Banks are the biggest investor in the government bond market (holding ~34.5% of outstanding papers). Low interest among banking community to maintain high SLR indeed affects bond prices. Recent spike in yields can be attributed to RBI’s hawkish stance (fear of rate hikes), less OMO expectation, global factors and unfavorable demand supply dynamics. RBI releases Investment to deposit ratio on a fortnightly basis. Recent numbers stands at ~29.8%(Oct 18, 2013) i.e. out of every 100rs deposit, banks invest ~29.8 in mandatory securities as specified by the RBI from time to time. This ratio is fairly low compared to same period previous year. Investment to deposit ratio as on Oct 19, 2012 was seen at ~30.7%. Normally banks increase SLR holding during uncertain and low growth bouts. Current situation should compel banks to keep investment to deposit ratio high. However that is not the case. This deciphers bank’s fear of taking a hit on P/L due to undue volatility in bond prices. If banks were to maintain a year before ratio of ~30.7% then probably excess demand of 730bn (~15% of net FY14 borrowing) would have supported gilt prices considerably.
More about Kush Sonigara on Google+