FIIs have sold Rs 5000-6000cr in bond markets: HSBC

After the large rally in the bond markets, yields have started to cool off, down 50 odd bps in the last 10 days or so. The consolidation in the bond markets has coincided with FII selling, which have been key drivers for the market.  

"Till mid of May, the FIIs totally bought around something like Rs 29,000 crore, and for the last 10 working days, we have seen a selling of something like Rs 5,000-6,000 crore in the bond markets by FIIs, which has led to some consolidation and in conjunction with what is happening on rupee also," Manish Wadhawan of HSBC told CNBC-TV18. He expects the new 10-year bond to hover between 7.15 and 7.25 percent before the next big move.  "For the past few days, the market has been reacting with a fear after listening to RBI governor I would say it is positioning itself with a view of no rate cut now," he says. Also read: Bond markets going through consolidation phase: Bagla Below is the edited transcript of his interview to CNBC-TV18. Q: Where do you think the 10-year is now headed in terms of where exactly the liquidity adjustment facility (LAF) is? How easy is the liquidity situation possibly going to pan out considering that the Reserve Bank of India (RBI) has also announced open market operations (OMOs) worth Rs 7,000 crore? A: The bond markets have seen a large rally in the month of May. We have seen yields going down somewhere around 50 basis points (bps). So there has been some kind of a consolidation, which has started appearing in the markets for the last 10 days. This coincided with some kind of Foreign Institutional Investors (FIIs) selling in markets, in bond markets also. They have been one of those important factors in this bond market rally because till mid of May, FIIs totally bought something like Rs 29,000 crore and for the last 10 working days we have seen a selling of some Rs 5,000-6,000 crore in the bond markets by FIIs. This has led to some consolidation and in conjunction with what is happening on rupee also. We expect that before we hit the data, which is going to start on 10th till 14th, the Index of Industrial Production (IIP) data, the trade deficit and the inflation numbers you could see the new 10-year bond. I am referring again; the new 10-year bond could be hovering between 7.15 and 7.25 before we take the next move. Q: At the moment at 7.22; does it factor in a rate cut from the RBI on June 17? A: No, it does not factor in a rate cut. In fact I would say that for the past few days the markets have been reacting with a fear after listening to RBI governor. It is positioning itself with a view of no rate-cut now. The final call would be taken only after the data comes in from 10th onwards. Q: With regards to the liquidity situation, how is that currently within the liquidity adjustment facility (LAF)? Where do you expect it to ease or what is the requirement possibly in terms of further OMOs at this point in time from the RBI and possible likelihood of even a cash reserve ratio (CRR) coming through? Do you expect an OMO next week as well because we will be closer to the advance tax payout? A: It would be really difficult to predict when RBI would do OMO. But on a big picture basis, I can just suggest that they would require to do OMOs worth minimum Rs 1.25 lakh to Rs 1.35 lakh crore this year. The overall reserve money targets what they have this is the only source of liquidity, which they can add to the system. CRR is already at 4 percent, I think that they would hold it for some more time for an emergency kind of a thing if the financial markets require it. So, the timing is very difficult to predict because on the policy day the hint was that when the Finance Minister was quoting that RBI would be liberal with OMOs, but it came after a lag of three or four weeks. For the whole year this is number what we expect and there should be more OMOs in the month of June. _PAGEBREAK_ Q: For the lay public, not much is known about the inflation indexed bonds. Have you studied them? A poll is indicating that today’s auction will end at a spread of 150-175 bps as an indicative yield over the Wholesale Price Index (WPI). Exactly, how do you bid for this? How do you arrive at this 150 over WPI? A: It is a very pertinent question. This is the first time inflation indexed bonds have been issued in this country. There are primarily three factors how do you price in these bonds, number one is the comparative nominal yield, basically where the 10-year is trading on a nominal bond, which is around 7.22-7.25. Second factor is the kind of premium, which you are supposed to ask the issuer because of the illiquidity of these premiums. What I simply mean is a 10-year bond trades around say Rs 10,000-20,000 crore, this could be only trading Rs 200-300 crore a day. So whatever basis points you ascribe to this and third is the discount, which you are willing to give to the issuer because he is confirming a real yield to you over inflation, over a 10-year horizon. Putting these numbers together, the issue here is how do we price it in India. We do not have any benchmark as of now. If we just do a copy paste from what happens in the developed world then the average real yield was coming to around one and half percent. I expect the cutoff limit in India also today would be somewhere around these numbers, around one and half percent and the rest will evolve as the auctions come. Q: Just another additional point with regards to inflation indexed bonds. How much demand do you actually see for this certain product and where exactly would you see the demand coming from? Would it be the FII basket or do you think there would be some amount of retail participation, which we could see? A: I have two answers to this. Number one is looking at the institutional market there has been pockets of demand from FIIs also and from the local institutions also and in local institutions typically the insurance companies and the mutual funds. So, you would see certain sectors demanding this bond. On the retail side, it is too early to come to that conclusion because RBI in any case has said that they would be offering specifically this paper in retail from September. We will need to change some kind of parameters for retail participation like in UK the principal part is tax exempt that is one of the biggest game changers, which can be - for demand from retail for this kind of a bond. What I am referring to is beyond the real yield we are talking about one and half or whatever that number would be today the principal indexed to inflation. So after 10 years if you are getting Rs 30 or Rs 40 extra that is completely tax exempt – that kind of a tax exemption would be required to get that participation from retail in India also. I think retail would come later, but as far as institutional market is concerned with the small sizes of auctions at the moment being planned you would see reasonable demand.