New Delhi's proposed tax may impact $19bn derivative bond trade
– New Delhi’s plan to tax high-value insurance policies may reduce demand for bond investments.
– Derivative trade that boosted demand for India’s sovereign bonds by billions is at risk.
– The government plans to borrow 15.4 trillion rupees in the fiscal year starting April 1, an 8.4% increase from the current period.
A $19 bn derivative bond trade in India is at risk due to a proposed tax on high-value insurance policies by the New Delhi government, analysts say. The move is expected to reduce demand for these policies and lead to a cutback on bond investments by the insurance industry, putting pressure on the sovereign bond market. Banks have been buying debt for interest-rate swaps offered to insurers in the past two years, enabling insurers to lock in future yields without increasing their balance sheets. The transactions account for an estimated $19 billion worth of sovereign bonds purchased by banks. If demand drops, it may be necessary for the Reserve Bank of India to support the market as Prime Minister Narendra Modi increases debt sales.
Government debt purchases due to the trade may drop by 15% to 20% with the tax change, according to Ashhish Vaidya, head of treasury at DBS Bank Ltd. The notional outstanding amount of bonds held by banks offering the deal may be around 1.6 trillion rupees ($19 billion). The trade, known as a bond forward-rate agreement, has led to robust demand for long-tenure bonds in recent months, with the yield on the benchmark five-year debt surging more than 140 basis points last year, compared to a rise of 39 basis points on the 30-year note. The government plans to borrow 15.4 trillion rupees in the fiscal year starting April 1, an 8.4% increase from the current period, as Modi seeks to bolster economic growth ahead of elections next year.
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