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S. Balakrishnan

THANKS to falling interest rates, the bond portfolios of banks have seen considerable appreciation in the last few years.

On top of this has been the increasingly frenetic trading activity in the gilts market — where turnover is close to Rs 10,000 crore on many days — prompting otherwise docile treasury desks to jump into the fray and earn profits from short-term price movements.

The economic calendar of the Indian bond trader is very simple — the weekly release of inflation numbers and forex reserves by the Reserve Bank of India. More important are the auction announcements and results.

Frantic guessing on the auction amounts and cut-off yields pushes the market from side to side. And, of course, there are the pronouncements on interest rates from the Governor downwards to unnamed senior RBI officials.

Just as the then US President, Mr Bill Clinton, gave new meaning to the word "is" during his impeachment, there is fierce disagreement on the significance of words like "soft" and "softer" in the context of domestic interest rates. "A whisper from him and the market goes berserk", remarked a US layperson about Mr Alan Greenspan, the Chairman of the US Federal Reserve. It could equally be said of Dr Bimal Jalan and his colleagues.

The new financial year has started and the RBI is back to its routine of raising money for the Government. It has done it with remarkable success in the past — so much so that interest costs for the fisc have almost halved in five years.

On second thoughts, perhaps the RBI cannot take all the credit for that: inflation has been rolling down, industrial growth has been lacklustre and as far as new project investments are concerned, the less said the better.

Liberalisation and free imports have killed off the traditional oligopolies in Indian business, increased competition and taken pricing power out of producers.

Bank capital is in far better shape, thanks to handsome treasury profits, which have enabled provisioning to a large extent, though not fully, for their non-performing loans.

Public sector banks, barring the few sick ones, have exceeded the central bank's minimum capital norms.

It is partly illusory. For lack of better opportunities, the banking system as a whole holds about 40 per cent of its assets in Government securities, which require no capital charge and carry no credit risk.

What is present — in fact an overdose of it — is market risk. A simple calculation shows that even with a capital adequacy of 15 per cent, 25 per cent of net worth is at risk if interest rates move up by 1 per cent.

If this sinks in, they may realise that the credit portfolio, with its far higher yields and collateralisation, is a better bet, even with a default ratio of 5 per cent, rather than ploughing money into gilts returning barely 6 per cent.

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