Shortselling seen helping a free fall in bond prices

MUMBAI: Bond houses may have precipitated the recent crash in the prices of government securities by actively borrowing bonds only to sell them in the market. Money market dealers say the overnight Repo market has been their main source of borrowing. Most bond houses have made some gains which could help them offset existing losses in their government security portfolios.

ICICI Securities, Securities Trading Corporation of India (STCI), Nomura, SBI-DFHI, Bank of India, Merrill Lynch are the leading bond houses in the country, also called primary dealerships (PDs). They specialise in the buying and trading debt securities and underwrite all the government bond auctions.

As per data with Clearing Corporation of India (CCIL), bond houses have net sold Rs 5,100 crore worth of bonds so far in December (till December 18), and the tally from November is as high as Rs 10,100 crore. Banks have bought bonds worth Rs 6,800 crore and Rs 4,100 crore in December and November, respectively, as per the data. CCIL clears and settles all government bond transactions in the country.

Ten-year bonds almost went into a free fall over the past two weeks, pushing yields to 14-month-highs, on speculation economic growth and accelerating inflation will prompt the central bank to increase interest rates. Yields on these bonds rose to 7.70% on Tuesday with a government report showing last week an index of food articles advanced 20% in the week ended December 5. The paper quoted at 7.24% on November 30. When bond yields rise, bond prices fall.

“The largest part of the selling registered by PDs is due to them disposing off bonds they have bought in auctions,” said Prasanna Patankar, senior vice-president at STCI Primary Dealership. “The rest is due to shortselling, since prospects of rate hike, liquidity tightening and inflation have soured the sentiment for government bonds,” he added. Selling securities (after borrowing them) in the hope they can be bought back later at a lower price is called short selling.

Other dealers explain that the overnight repo market has seen increased activity from bond houses recently. Here a dealer borrows securities on an overnight basis and sells them since he thinks prices will fall. In case his or her bet goes right, he can later pick up the bond at a lower price and return it back to the lender.

“On the positive side(for bonds), correction to the fear of currently priced-in aggressive monetary tightening and the current lack of appreciation for potential fiscal improvement could be bond-friendly,” said Rajeev Malik, senior economist with Macquarie Research. “On the negative side, gross government borrowing will still be pretty large despite the shrinkage in net borrowing,” he said in a report.