Bondster

Goldman Sachs comes to Indian Bond markets Yield

“If we don’t show up Monday, it’s because we’ve hit the jackpot.”Lloyd Blankfein, Goldman Sachs CEO

Goldman Sachs has finally made its foray into the Indian sovereign bond markets and the forte of large banks only.

The entry through its subsidiary, Goldman Sachs India Capital Markets Pvt Ltd, was formally approved by the Reserve Bank of India (RBI) on April 15, an auspicious day for many in the country since it is the beginning of the sowing season.  Goldman Sachs starts operations on Monday or April 19, 2011. The entry brings in the action of leveraged capital into domestic bonds that was so far confined to only the equity markets.  Leveraged capital has played havoc in the equity markets, driving market capitalization of to over $1.8 well over India's nominal GDP.  It is not that Goldman Sachs is not already in the debt markets. They are there through the Foreign Institutional Investor route. This route is governed by a physical ceiling.

Leveraged Capital Action

The Goldman entry, with some flab from the Fed's QE1 and QE2, somewhat contradicts concerns expressed by the Reserve Bank of India.  At the Bank of International Settlements'  Special Governor's meeting in Kyoto in January this year, the RBI Governor D Subbarao said, "Our reserves comprise essentially borrowed resources, and we are therefore more vulnerable to sudden stops and reversals as compared with countries with current account surpluses."

Nevertheless the rules have changed from Monday, though the fundamental precepts remain the same, whether in financial markets or on the roads in the country - "Signal Left, turn right and vice versa!" 

With Goldman Sachs entry Indian bond markets traders can expect some real leveraged capital action. Leveraged capital means using borrowed funds. With the greenback as the currency for the global carry trade leveraged capital is the route to go. Goldman has the skill to bring cross border funds though multiple sources. With six month LIBOR at 0.46 per cent, the spreads are huge. Ten year yields as measured by the benchmark 7.80 per cent due April 2021 was 8 per cent.

Although, foreign investors in Indian debt don't contribute to any escalation in sovereign external debt costs, bonds are likely to turn extremely volatile. Volatility in bonds is already apparent. In just one week ten year yields on the newly issued 10 year bonds have moved up 20 basis points. Yield spreads between one and ten year are just 60 basis points implying a flat yield curve.

Technology driven volatility

Increased volatility is likely from Flash Trades or High Frequency Trading (HFT) with supercomputers and complicated algorithms, all Goldman specialties.  These are most likely to make their presence in the Indian bond markets. With the entry of the likes of Goldman, wild swings would inevitably spillover into the foreign exchange markets. These high technology trading arsenal are therefore essential kits if currency depreciation losses are to be minimized and returns are to be maximized. A foreign investor in Indian bonds benefits, if the Rupee appreciates against the U S $.  The cross border investor is able to lock into a favourable exchange rate and remain unaffected even if there is currency depreciation at the time of exit. 

Cross border investors also have access to enormous hedging tools. So foreign exchange markets volatility could also substantially escalate. Foreign exchange markets are already volatile. Since the beginning of April this year exchange rates have swung between Rs 44.04 to the dollar to Rs 44.61.

The RBI and the government want only long term funds.  But leveraged capital is not necessarily long term since they are float or callable funds. And purchases of ten-year or longer tenure bonds are not long term investments. Besides, Short selling is already permitted in bonds, through the "when issued route." This means that banks or institutions short sell a security before it is actually issued. If the yields at the time of allotment is high, then the short seller benefits.

But as many bidders found, short selling also could also result in losses. Bidder in the first auctions of this fiscal year found that out. At that time short sellers had pushed the 10 year YTM down to 8.1 per cent. With the cut off price at 7.80 per cent many banks including American and British Banks ended up with a 30 bps deficit.

Who benefits?

For government borrowings, Goldman Sachs and leveraged investor entry means the short run is likely to be beneficial. In the first half of the financial year, when the bulk of the government borrowings are expected to take place, borrowing costs are likely to be kept low. This year, before September, of the Rs 4.17 trillion borrowing target, at least Rs 2.5 trillion has to be raised .

That yields would not be allowed to rise during the period was evident from the extension of the Liquidity management measures. This measure instituted in December last year provides exemption to banks from the prescribed minimum investment in government securities against their borrowings from the RBI's repurchase (liquidity support) window. The prescribed minimum investment prescribed is currently 25 per cent of the outstanding deposits and some categories of subordinated debt. The exemption permits banks a one per cent shortfall without any penal levies.

The exemption was motivated from fear that yields could harden, although there are no bond market vigilantes as yet in this country.  

The fears were triggered by the Certificates of Deposit markets, where the cost of raising six month funds is 9.10 per cent, a 50 bps jump in just 7 days. Besides, Friday's (April 15, 2011) auctions saw devolvement to underwriters of Rs 8.75 billion as bids were rejected since they were lower than the cut off prices.     

             

If sovereign borrowing costs are rising then other borrowers are not raising funds cheap. Triple A rated corporate debt is currently at a spread of 150 basis points over sovereigns are among the highest in the world, implying high risk aversion. (One year TED spreads are just 75 bps). In the case of lesser credit worthy sectors, small industries and self employed sectors  the spreads are far higher or credit is simply not available.

Are Goldman Sachs and foreign investors expected to help correct the situation by increasing liquidity through increased bond trading using global resources? In the short term leveraged capital is likely to benefit both government and corporate borrowings.  Along with it, though comes a host of other risks; inflation is just one of them. Besides Goldman Sachs and their associates presence have also curiously coincided with an escalation of systemic risks. Greece is the latest casualty. There could be others in the making. Surely, we don't need to join them.