Indian insurers are turning to state government bonds for a popular derivatives trade, locking in higher yields amid record provincial debt supply.
ICICI Prudential Life Insurance Co., Axis Max Life Insurance Ltd. and Shriram Life Insurance Co. are among major insurers that entered bond forward contracts with banks since late January. Under these agreements, lenders commit to selling securities at a fixed price on a future date. While insurers have long used such instruments, they were typically linked to federal government notes.
More than a quarter of total volumes in bond forwards and their rate agreements — a similar cash-settled derivative — since February have been tied to state bonds, according to data from Clearing Corp. of India. About half of the trades in the segment are now linked to such securities, up from only sporadic activity earlier.
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Derivatives linked to state debt are gaining momentum as the yield gap between provincial and benchmark notes widens to a multi-year high. They are also turning to the trade as the long-tenor bonds align better with their asset-liability needs, said Sachin Bajaj, chief investment officer at Axis Max Life Insurance.
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The growing appetite for these instruments follows the largest-ever borrowing plan of 5 trillion rupees ($53.6 billion) by states for the quarter ending March, said Ketan Parikh, head of fixed income at ICICI Prudential Life Insurance.
“The 15- to 20-year state bonds are trading at a 50-60 basis points spread, providing a sweet spot for insurers to lock in higher yields,” he said. The yield premium was about 45 basis points at the end of December.
The pickup in state bond forwards coincides with the final quarter of India's April-to-March financial year, when insurers typically see a jump in premium collections and deploy those inflows into long-term assets that match liabilities.
State bonds become the “natural choice” at this time of the year, as the federal government has concluded its borrowing program, said Ajit Banerjee, chief investment officer at Shriram Life Insurance. “With so many counter-party banks offering the option, it has become one of the preferred bond derivative instruments.”
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