Impact Of State Bonds Supply: Increase In Yield Spread

Context:

The yield spread between 10-year state bonds and 10-year government bonds has widened by 8-10 basis points (bps) in the current quarter of the financial year (2023-24) due to the increased supply of state bonds.

“Yield” – Returns on Investment

“Yield” refers to the earnings generated and realized on an investment over a particular period of time.
It’s expressed as a percentage based on the invested amount, current market value, or face value of the security.

Yield Spread: Understanding Differences in Debt Instruments

A yield spread is the difference between yields on differing debt instruments of varying maturities, credit ratings, issuers, or risk levels.
A yield spread is calculated by deducting the yield of one instrument from the other.
- This difference is most often expressed in basis points (bps) or percentage points.

A Government Security (G-Sec) is a tradable instrument issued by the Central Government or the State Governments. It acknowledges the Government’s debt obligation.
Types of G-SECs on the basis of maturity:
- Short term (usually called treasury bills, with original maturities of less than one year)
- Long term (usually called Government bonds or dated securities with original maturity of one year or more).
- Issuing Authorities: In India, the Central Government issues both, treasury bills and bonds or dated securities while the State Governments issue only bonds or dated securities, which are called the State Development Loans (SDLs).
G-Secs carry practically no risk of default and, hence, are called risk-free gilt-edged instruments.
Dated G-Secs: Exploring Fixed and Floating Coupon Securities
- Dated G-Secs are securities which carry a fixed or floating coupon (interest rate) which is paid on the face value, on a half-yearly basis.
  - Generally, the tenor of dated securities ranges from 5 years to 40 years.
Cash Management Bills (CMBs)
- In 2010, Government of India, in consultation with RBI introduced a new short-term instrument, known as Cash Management Bills (CMBs), to meet the temporary mismatches in the cash flow of the Government of India.
- The CMBs have the generic character of T-bills but are issued for maturities less than 91 days.

Instruments of Government Bonds in India:

Fixed-rate bonds: Government bonds of this nature come with a fixed rate of interest which remains constant throughout the tenure of investment irrespective of fluctuating market rates.
Floating Rate Bonds: As the name suggests, FRBs are subject to periodic changes in rate of returns. The change in rates is undertaken at intervals which are declared beforehand during the issuance of such bonds.
- For instance, an FRB could have a pre-announced interval of 6 months; which means interest rates on it would be reset every six months throughout the tenure.
Inflation-Indexed Bonds: It is a unique financial instrument, wherein the principal, as well as the interest earned on such bond, is accorded with inflation.
- Mainly issued for retail investors, these bonds are indexed as per the Consumer Price Index (CPI) or Wholesale Price Index (WPI).

Treasury bills or T-billsTenure
- Treasury bills or T-bills, are money market instruments, are short term debt instruments issued by the Government of India and are presently issued in three tenors, namely, 91 day, 182 day and 364 day.
- Discount Issuance and Face Value Redemption:Treasury bills are zero coupon securities and pay no interest. Instead, they are issued at a discount and redeemed at the face value at maturity.
  - For example, a 91 day Treasury bill of ₹100/- (face value) may be issued at say ₹ 98.20, that is, at a discount of say, ₹1.80 and would be redeemed at the face value of ₹100/-
State Development Loans(SDLs):
- State Governments also raise loans from the market which are called SDLs.
- SDLs are dated securities issued through normal auction similar to the auctions conducted for dated securities issued by the Central Government
- Interest Servicing: Interest is serviced at half-yearly intervals and the principal is repaid on the maturity date. Like dated securities issued by the Central Government, SDLs issued by the State Governments also qualify for SLR.

G-Secs are issued through auctions conducted by RBI.
Electronic Auction Platform: Auctions are conducted on the electronic platform called the E-Kuber, the Core Banking Solution (CBS) platform of RBI.
Indicative Auction Calendar: The RBI, in consultation with the Government of India, issues an indicative half-yearly auction calendar which contains information about the amount of borrowing, the range of the tenor of securities and the period during which auctions will be held.
Auction Notifications: A Notification and a Press Communique giving exact particulars of the securities, viz., name, amount, type of issue and procedure of auction are issued by the Government of India about a week prior to the actual date of auction.
T-Bills Auction Schedule: The Reserve Bank of India conducts auctions usually every Wednesday to issue T-bills of 91 day, 182 day and 364 day tenors. Settlement for the T-bills auctioned is made on T+1 day i.e. on the working day following the trade day.