Understand Debt Switches

In FY20 the Government of India conducted the conversion/switch of its securities through auction operations of Rs 2.249 trillion.

Conversion of Government of India (GoI)’s Securities - FY20

What are bond switches?

The government, in order to bring down the pressure in financing such bunched up maturities, is undertaking a Debt Switch program where it will buy back bonds maturing in the years FY20-25 and replace them with bonds that mature later than 2029-30. How does this work?

Let’s take an example. LIC holds Rs 50 billion of 7.38% 2015 government bond maturing on the 3^rd of September 2015. The government does a debt switch with LIC, where it buys the Rs 50 billion of 7.38% 2015 bond from LIC and sells Rs 50 billion of 8.60% 2028 bond to LIC. In effect, this debt switch will lower by Rs 50 billion, the redemption pressure on the government, when the 7.38% 2015 bond comes up for repayment on the 3^rd of September.

The debt switch has no impact on the government’s and LIC’s cash flows except for the difference between the price at which it buys back bonds from LIC and the price at which it sells bonds to LIC. The debt switches are done at market price as of the switch date. In the example above, if government bought 7.38% 2015 bond at Rs 100 and sold 8.60% 2028 bond to LIC at Rs 107, the price difference of Rs 7 will be a net inflow to the government and net outflow for LIC.

Market is Positioning for New 10yr G-sec Post Bond Switch Auction – August 2019

The total outstanding amount for 7.26% 2029 bond after RBI’s recent switch auction is Rs 1,098.32 billion, the maximum RBI has issued any bond is up to Rs 1020 billion. The ten year benchmark 7.26% 2029 bond is likely to remain under pressure on the expectation that RBI will issue new ten year bond in the next two month.

In August 2019 Government of India, has converted  securities maturing in 2019-2020 & 2020-2021, having a total face value of Rs 220 billion to a longer tenor security maturing in 2028-29 & 2038-2039 through a bond switch auction. Total amount of Rs 155.65 billion source securities were accepted while amount of Rs 152.64 billion destination securities were issued in the auction.

Government Securities Switches/Conversion Auction held on August 19, 2019

RBI Bond Conversion Sends Wrong Signals 

Conversion of government securities from one maturity to another is a way of government postponing its debt repayment. RBI converted one of its government bond holdings from near term maturity to longer term maturity to enable the government to postpone its debt repayment.

Should the RBI convert its holdings to longer maturity bonds through conversions and switches? By doing so, the RBI is enabling the government to spend the money it would otherwise have used for debt servicing. If a corporate does the same, bond holders will suffer as they may not want to hold longer maturity debt of the corporate.

Government should auction out switches to allow the market to determine the true cost of switches rather than covertly going to RBI or other state run institutions for conversions/switches.

G-sec switches and buy backs (Rs billion)

On 3rd March 2016 two G-secs worth Rs 373 billion maturing in 2016-17 and 2021-22 were switched by RBI from its own account to longer maturity 2023-24 and 2024-25 bonds respectively with the  government.

On 20th March 2015 bonds worth Rs 302.28 billion maturing in 2015-16 were switched by RBI from its own account to longer maturity 2026-27 bonds with the  government.

The government is facing a heavy bond maturity calendar over the five years. Government bonds worth Rs 11.57 trillion are maturing over the period 2015-16 to 2019-20. Given that the government does not generate budget surplus to bring down debt, it has to borrow to pay bondholders. Hence, the government has to borrow extra Rs 11.57 trillion over and above its fiscal deficit borrowing over the next five years.

The bond market may not be able to absorb such high borrowing given that banks, that own 43% of total outstanding government bonds, have seen a cut in SLR from 25% of NDTL to 21.5% of NDTL over the last few years. Bank deposit growth has also slowed down from over 15% levels to levels of around 11.5% and banks may not have appetite to roll over their bond holdings. Read RBI Regulations for SLR and NDTL definitions.

In Budget 2013-14 and Budget 2014-15, the government announced a debt switch of Rs 500 billion in each of the budgets. In fiscal 2013-14, the government switched bonds maturing in 2014-15 and 2015-16 with institutional investors for face value of around Rs 310 billion to longer tenor securities during the months of January and February 2014. Over and above the switches, the government also bought back securities (with cash surplus) amounting to Rs 155.90 billion in March 2014 to smoothen the maturity profile of outstanding dated securities in 2014-15. Buying back of securities extinguishes the bonds and the government will have not have to fund the bonds when they come up for maturity.

In fiscal 2014-15 the government bought back bonds (with surplus cash) amounting to Rs 188 billion in September 2014, of which Rs 125 billion has already matured.In March 2015 bonds Rs 302.28 billion maturing in 2015-16 are switched to longer maturity 2026-27 bonds.The government has switched a total of Rs 608.28 billion in fiscal 2014-15 apart from buy backs.