KATHMANDU: Yield on development bonds, regardless of their maturity period, has fallen to an all-time low, dampening sentiment of bankers, who have to tap the government securities market to meet some of the regulatory requirements.

Return on 15-year development bonds floated today by Nepal Rastra Bank (NRB) dropped to 2.65 per cent, the lowest since February 1964, when the government first introduced development bonds with a maturity period of five years to raise debt from the domestic market to finance development activities.

Surprisingly, returns on these securities are falling lately even as their maturity period is increasing.

When NRB auctioned five-year development bonds on May 28, the weighted average cut-off rate stood at four per cent. Then on June 4, when it floated seven-year development bonds, the return fell to 3.44 per cent.

The yield further dropped to 3.08 per cent when NRB offered nine-year development bonds on June 11.

The freefall continued on June 25 as well, when 10-year development bonds were floated. At that time, the weighted average interest rate had dropped to 2.99 per cent.

Considering 7.1 per cent inflation of mid-May, returns on these securities are negative in real term.

“Yields on bonds are falling rapidly because of excess liquidity in the banking sector,” Nara Bahadur Thapa, chief of Public Debt Management Department at NRB told The Himalayan Times.

Banks and financial institutions (BFIs) are currently sitting on excess liquidity of over Rs 70 billion. However, a large chunk of this money cannot be extended as loans because it is being used to meet the minimum regulatory net liquid asset to total deposit ratio, or LD ratio, of 20 per cent.

So, BFIs are rushing to grab these low-yielding securities assuming it is wiser to invest funds in bonds and get some returns rather than let them sit in coffers and generate no return.

Lately, what also appears to have exerted pressure on yields is the government’s decision to repay a part of debt.

So far this fiscal, the government has repaid Rs 42.55 billion of debt, including principal, shows the latest NRB report.

On the other hand, fresh government securities worth only Rs 42.34 billion have been floated in the market. This means net borrowing of the government stood at a negative of around Rs 211 million.

“Because of this, BFIs are rushing to replenish their stock of government securities to maintain LD ratio. This is raising the demand for bonds,” Thapa said, adding, “This is another reason for fall in bond returns.”

The falling bond return is, in fact, good news for the government, as it is now able to raise domestic debt at low interest rates. This means the cost of rebuilding parts of the country ravaged by the earthquake would be a little cheaper.

But bankers say this is creating ‘distortions’ in the market.

“Many BFIs that have purchased low-yielding instruments are now carrying a lot of market risk,” said Sashin Joshi, CEO of Nabil Bank.

This is because purchase of nine-, 10- and 15-year bonds is not a short-term investment, according to Joshi.

“And if returns on bonds rise next year, the instruments bought this year will turn into nothing but loss-making tools. At that time, many BFIs will have no option but to sell those instruments at a discount. This may hit their profitability as well,” Joshi added.