Kathmandu, April 1

Bond yields have rebounded after making a steep fall in the last fiscal year, signalling the central bank’s efficacy in liquidity management.

Return on 11-year development bonds floated yesterday by Nepal Rastra Bank (NRB), the central bank, jumped to 4.44 per cent, shows the latest report of NRB. This return is 0.47 percentage point higher than 3.97 per cent recorded on March 13, when NRB had floated development bonds with maturity period of eight years.

“Yields on bonds have started going up in line with inflationary pressure that is building in the economy,” said Min Bahadur Shrestha, head of the Public Debt Management Department at NRB, which issues bonds on behalf of the government.

Inflation stood at 11.3 per cent in mid-February. But considering the pace at which consumer prices are rising, the real returns on bonds are still in negative territory — albeit these yields are better than those of the last fiscal year, which ended in mid-July.

Last fiscal year, yields on development bonds had started tumbling even when maturity period of the debt instruments was rising, causing jitters among banks and financial institutions — the major buyers of these securities.

When the central bank floated five-year development bonds on May 28 last year, return stood at four per cent. The yield fell to 3.44 per cent by the time NRB issued seven-year bonds on June 4.

The return further dropped to 3.08 per cent on June 11 when bonds with maturity period of nine years were floated. These instruments continued to come under pressure on June 25 as well, with return on bonds with 10-year maturity period falling to 2.99 per cent. The result was even worse when 15-year bonds were issued, with yield dipping to 2.65 per cent.

Falling bond returns in the last fiscal year indicated higher demand for these debt instruments, which was not matched by supply.

Demand for bonds had gone up in the last fiscal year, as excess liquidity in the banking sector hovered around Rs 70 billion. There was very little bankers could have done with this money, apart from letting it sit idle, as it was being used to meet the minimum regulatory net liquid asset to total deposit ratio, or LD ratio, of 20 per cent.

“The situation is not the same this year, as excess liquidity in the banking system currently stands at around Rs 25 billion,” said Shrestha. “This is also one of the reasons why returns on bonds are going up.”

But the liquidity situation will not remain the same, as Rs 60 billion will be injected into the banking system in between mid-April and mid-May when term deposit instruments, being used by NRB to mop up excess liquidity, expire.

“However, we will be floating an array of debt instruments worth Rs 42.25 billion during that period, which will absorb the funds that have gone back into the banking system,” said Shrestha. “Also, we will continue to use money market instruments to mop up excess liquidity.”

His statements are an indication that bond yields will not dip to the level seen in the last fiscal year.

Falling bond returns are, in fact, good news for the government, which can borrow money for longer period at cheaper prices to fund its deficit financing needs. But they also tend to distort the market because lower yields hit the profitability of banks and financial institutions.

Despite this fact, banks and financial institutions generally rush to grab low-yielding bonds when they have excess liquidity because they deem it wiser to invest funds in these debt instruments and get some returns rather than let them sit idle in coffers and generate no return.