Sluggish state auction exposes bond market reform hurdles

A move to make the pricing of roughly $30 billion in debt sold each year by individual states more market-based has met with resistance from both issuers and investors, underscoring the difficulties it faces in deepening its bond markets.

The Reserve Bank of India (RBI) this month proposed to scrap a 14-year-old system under which state debt is valued at a fixed spread of a quarter-percentage point over government bonds, though it said that the recommendation is not final.

Two auctions of state debt held since the rule was proposed, including one on Tuesday, fell short of targets as investors, mainly state banks, worry that they will be forced to book losses if their holdings are subject to market pricing.

"Demand has already come down for SDLs (state development loans). If it becomes a rule, then investors are staring at losses on their existing portfolio,"  Anindya Dasgupta, managing director in Mumbai at UK-based lender Barclays said.

"But this is the right thing to do. Mark-to-market should be based on traded or auctioned yields," he said.

A senior official at a large state bank said some lenders may see mark-to-market losses of about 60 basis points on their state bond portfolios if the rule is implemented as proposed. "There was a bonus for investing in SDLs which won't be there anymore," he said on condition of anonymity.