Banks stare at MTM hit as bond yields climb

Yields on sovereign bonds rose sharply after the Centre announced additional borrowing of 50,000 crore for the current financial year, spurring concerns that the government may fail to meet its fiscal deficit target of 3.2% of GDP for 2017-18.

The yield on the benchmark 10-year bond jumped 18 basis points (bps) to 7.40%, the highest level since 7.43% on April 7, 2016. Bankers and economists said bond yields could climb further. "We expect the 10-year benchmark yield to move to 7.5% levels by June," economists at HDFC Bank wrote in a note to clients.

"The only sigh of relief could be FY19 budget announcement in February - in case the government decides to go for fiscal consolidation (fiscal deficit from 3.5% in FY18 to 3.2% in FY19). However, with general elections due in 2019 (which often propagates for populist measures) and amidst an ongoing economic recovery, it seems unlikely that the government would like to withdraw its support and opt for aggressive fiscal consolidation next year," they wrote.

Banks now face the possibility of incurring mark-to-market (MTM) losses due to the surge in bond yields in the third quarter. Lenders need to set aside capital as provision for losses incurred due to a fall in bond prices. Bond prices and yields move in opposite directions.

"There is not much appetite in the market… volumes are low," said a bond dealer with a large public sector bank, who did not wish to be named. "Yields could rise further." The yield on the benchmark government bond has already surged 73 bps so far in the October-December period.

Banks are already struggling to meet the increase in the provisioning requirement for the rise in bad loans. The MTM losses on their bond holdings could add to the pressure on lenders' third-quarter financials. Friday is the last trading day of this quarter.