Bond yields have surged to the highest level in the last five years, as the portion of excess liquidity in banking institutions is shrinking due to jump in supply of debt instruments.

An auction launched on Thursday to issue development bonds with maturity period of eight years saw bond yield curve steepen to 6.2 percent. This is the highest return since June 6, 2012.

The Nepal Rastra Bank, the central bank, floats development bonds on behalf of the government every year. The money raised from sales of these bonds is used by the government to bridge deficit of financial resources and cover various expenses, including those related to development works. Banks and financial institutions must subscribe to these bonds to maintain the regulatory requirement on statutory liquidity ratio.

The cycle of raising debt from the domestic market used to begin in the third quarter of the fiscal year in the past. But the central bank bucked this trend in the current fiscal year and started offering bonds from the first quarter of the fiscal year. This was done to ensure fund transfers of Rs75 billion made to newly-formed local bodies at the beginning of the fiscal year does not create shortage of funds for the government.

So far this fiscal year, the government has raised Rs25.1 billion from treasury bills of various maturity periods and another Rs67 billion from development bonds. On top of this, Rs84.7 billion has also been mopped up from the market through reverse repo, a money market instrument.

“Since various instruments are being floated rapidly, the chunk of excess liquidity at banking institutions is becoming thin. As a result, rates are going up,” said Nara Bahadur Thapa, executive director of the Research Department of the NRB. The banking sector currently has excess liquidity of around Rs30 billion, according to the NRB.

If the current trend continues, rates will further go up as banks’ appetite for these debt instruments has started going down.

When the NRB first floated development bonds worth Rs5 billion in the current fiscal year, they were oversubscribed by over 300 percent. When bonds of the same amount were launched on Thursday, they were oversubscribed by only 93 percent.

The NRB floats 80 percent of development bonds in the form of competitive tender and the rest in the form of non-competitive tender. This means 80 percent of the bonds are up for grabs through competitive bidding process and the remaining through non-competitive bidding. The cut-off rate fixed for bonds floated through competitive bidding process applies for bonds floated through non-competitive bidding.

The competitive bidding is open to banking institutions, like commercial banks, development banks and finance companies, and non-banking institutions, like insurance companies, Employees Provident Fund, Citizen Investment Trust and merchant banks. But the non-competitive bidding is only open to non-banking institutions.