10-year Benchmark G-sec yield flirts with 8% mark for the first time in 3 years, witnesses steepest hardening in recent times

The recent Monetary Policy Review saw Reserve Bank of India’s first rate hike in more than four years, a change in stance that saw 10 year benchmark G-sec yield almost touching the 8% mark for the first time in 3 years (since June 2015). The 10-year benchmark G-sec acts as a fair indicator of the investors’ sentiment of the Indian fixed income market.  The benchmark yield has seen the steepest per year increase in yield in recent times with ~180 bps hardening since the trough of 6.18% achieved in November 2016.

Domestic debt market has been primarily dominated by Government securities. In FY17-18, the amount outstanding in Government securities reached Rs. 53.2 trillion representing a sizeable market share of ~65% in sovereign debt market (constituting G-secs, T-bills and State Development Loans) and ~45% in the entire Indian fixed income market. With an average ~30% share of secondary market trades in the Indian G-sec market, the ‘on-the-run’ 10-year benchmark G-sec represents the most liquid maturity segment of the G-Sec market.

The NIFTY 10-year Benchmark G-Sec Index captures the price change and accrued interest of on-the-run 10-year G-Sec. Additionally, NIFTY 10-year Benchmark G-Sec (Clean Price) Index captures only the price change of ‘on-the-run’ 10-year G-Sec.

Exhibit 1: Performance of NIFTY 10-year Benchmark G-sec index during various phases

1*Data ended June 7, 2018

#Returns reported during Phase 3 are absolute returns for the 5 month period from August 2008 to December 2008.

Continue reading “10-year Benchmark G-sec yield flirts with 8% mark for the first time in 3 years, witnesses steepest hardening in recent times”

Green Bonds

By Vijeta Singh

Green bonds are like regular bonds, but the money raised from these bonds goes towards the funding of ‘green’ business activities or projects in fields such as renewable energy, sustainable waste management, etc. These bonds are generally certified by Green Bond Principles (issued by International Capital Market Association) and Climate Bond Standards (issued by Climate Bonds Initiative) to ensure they are to finance projects that would generate environmental benefits.

These bonds can be in different forms, the most common being the full recourse green bond which is earmarked exclusively for environmentally beneficial projects. There are other varieties such as green ‘use of proceed’ revenue bonds and green securitized bonds.

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# Fincabulary20 – Yield Pickup

MeaningThe additional interest rate an investor receives when selling a lower-yielding bond in exchange for a higher-yielding bond.

The bond with the lower yield generally has a shorter maturity, while the bond with the higher yield will typically have a longer maturity. A certain amount of risk is involved since the bond with a higher yield is often of a lower credit quality. Additionally, the investor can be exposed to interest rate risk with the longer maturity bond. For example, an investor owns a bond issued by Company ABC that has a 4% yield. The investor can sell this bond in exchange for a bond issued by Company XYZ that has a yield of 6%. The investor’s yield pickup is 2% (6% – 4% = 2%). Ideally, a yield pickup would involve bonds that have the same rating or credit risk, though this is not always the case.

WEATHER DERIVATIVES – CONCEPT, CHALLENGES, AND FEASIBILITY

By  Ishan Kekre & Girish C

Introduction

A weather derivative is a tool for managing weather risk. It is a financial contract that allows a firm to hedge itself against unexpected and adverse weather. A weather derivative contract or WD derives its value from future weather conditions. Contrary to stereotypical weather insurance, the payout of this kind of derivative is based on a parametric weather index. For instance, the index could be centimeters or millimeters of rainfall. The index could also be a cumulative frequency distribution of temperatures across many locations. The underlying of WD could also be related to snowfall or hurricanes.

Origin of Weather Derivatives

The weather derivative market as compared to other financial instruments is relatively young. The first transaction in the WD market dates back to 1997. The sector developed due to the severe repercussions of El Niño. These events were forecasted correctly by the meteorological community. Firms that had their revenues linked to weather realized the importance of protecting themselves against seasonal weather risks. Many companies who were in the business of dealing with financial futures and options saw WDs as attractive tools to hedge weather risks.

The insurance sector achieved substantial financial consolidation. As a result, there was significant capital to hedge weather risks. Insurance firms started writing options with payoffs linked to weather events. This, in turn, elevated the liquidity for the development of a WD market. Thus, the WD market evolved over the years into a strong over-the-counter market.

Continue reading “WEATHER DERIVATIVES – CONCEPT, CHALLENGES, AND FEASIBILITY”

Budget Impact Analysis – Banking & Financial Sector

By Payal Sachdeva and Tuhina Kumar

Expectations

  1. Increase in tax concessions on bad loan provisioning as the Asset Quality Review by RBI has led to a steep increase in provisioning.
  1. The total requirement of capital infusion by banks till march 2019, as gauged in 2015, is 1,80,000 crores out of which the government has committed to allocate only 70,000 crores under the Indradhanush plan. The rest is expected to be raised by the banks from the markets. This may be difficult due to low valuation of the banks.
  1. Disinvestment in PSU banks to below 51% to help raise capital.
  1. Higher allocation to infrastructure, housing and urban development as a boost in the commodity sector would improve the banks’ asset quality.
  1. Provide a roadmap of incentives for a digital push.
  1. Enhance capital expenditure for credit demand revival.

Announcements made in the Budget

  • Abolishment of FIPB: The Foreign Investment Promotion Board (FIPB) will be abolished in 2017-2018. FIPB is the body responsible for approving FDI proposals which are not cleared through the automatic route. Since 90% of the FDI inflows are through automatic route, the government has taken up this measure. Also, it focusses on ease of doing business.
  • Housing Finance:  Under the government’s aim to provide housing for all by 2020, the government proposed various measures. National Housing Bank (NHB) will refinance loans worth 20k crore in 2017-2018. This move saw a rise in stocks of HDFC (3.6%) and LIC Housing Finance (2.78%).
  • Tax relief on Masala Bonds: The government has announced that the rupee-dominated offshore bonds, called masala bonds will be subjected to a lower tax deducted at source (TDS) of 5%. This would be applicable retrospectively from 1st April 2016. This has been done to provide relief arising due to the appreciation of rupee against a foreign currency.
  • Law on Money Laundering: To curb money laundering by high net worth individuals via fake long-term capital gains, the government has tightened the screws on long-term capital gains. Only those equity investments are eligible for long-term capital gains where securities transaction tax (STT) has been paid.
  • Move to attract FPI: In order to attract funds from FPI, the finance minister made a proposal to exempt category I and category II FPIs from the provision of indirect tax transfer. Category I foreign portfolio investors include foreign central banks, sovereign wealth funds, and government agencies.
  • Recapitalization of banks: The government is going to infuse 10,000 crores out of the 70,000 crores committed under the Indradhanush plan for recapitalization of banks.
  • Set up PARA: An idea to set up a centralized Public Sector Asset Rehabilitation Agency (PARA) that will take over banks’ largest and the most challenging bad loans. PARA will help reduce NPAs and restructured loans.
  • Amendment in SARFAESI Act: The amendment in the SARFAESI act will allow listing and trading of security receipts issued by securitization company or a reconstruction company on SEBI-registered stock exchanges. This will boost capital flows in the securitization industry and aid in dealing with NPAs.
  • Mudra Yojana: The Pradhan Mantri Mudra Yojana has been allocated 2.44 lakh this fiscal as it exceeded the target of 1.22 lakh crore allocated in the year 2015-16.
  • Attempt to push Digital Economy: In an attempt to promote digital transactions in the Indian economy, the allocation to BharatNet Project has been increased by Rs 10,000 crore in 2017-18 which will connect 150,000-gram panchayats with high-speed broadband. Also, BHIM, an Aadhaar-based mobile wallet, would be promoted under two schemes, a referral bonus scheme for individuals and a cashback scheme for merchants.
  • The Role of SIDBI: Moreover, the government wants to ease loan disbursement, where the Small Industries Development Bank of India (SIDBI) would refinance credit institutions for extending unsecured loans to borrowers at reasonable interest rates based on their digital transaction history.

Conclusion

The government has met most of the expectations except for more capital infusion in the banks.  Thus, markets reacted positively to the budget and financial stocks shot up. Both Nifty and Sensex closed at a 3-month high of 28000 and 8700 respectively.

Stock Recommendation

The government’s move towards affordable housing is likely to push CanFin Homes as its loan portfolio is skewed towards the same.