It is nearly 12 noon on January 2 and Arun Kaul, managing director, PNB Gilts, can hardly contain himself. Every 10 minutes he strides out of his room to the nearby trading cubicle where half a dozen traders are buying and selling government securities at lightning speed.

Profits are zooming at an extraordinary speed and PNB Gilts' profits are up several millions by 1pm.

These are extraordinarily good days for the little known PNB Gilts. For the last two weeks the debt markets have been spectacularly volatile and PNB Gilts has grabbed the opportunity with both hands.

Kaul won't say exactly how much the company has made because of Sebi regulations. But it would be safe to guess that it has been raking in between Rs 4 crore (Rs 40 million) to Rs 6 crore (Rs 60 million) every day this week.

Did someone say Arun Kaul who? Or, did someone say they've never heard of PNB Gilts? If you've never had anything to do with the debt market -- like most people -- then the chances are that you haven't heard of Kaul and his small 43-employee team. But PNB Gilts -- along with IDBI Capital Markets -- is by far the biggest players in the debt market. And PNB Gilts makes amazingly high profits.

What's more astonishing is that PNB Gilts isn't a multinational investment bank with glitzy offices in south Mumbai.

It is a public sector company operating from the Punjab National Bank building built in the mid-'50s in Delhi's Parliament Street.

Step out of the lift and it looks like many other sleepy public sector offices. The landing on the staircase half a floor above is filled with broken furniture and unwanted planks of wood. In fact, there isn't the slightest sign of the frenetic trading activity and the fact that huge amounts of money are being made a few feet away.

Nevertheless, it would be very wrong to draw conclusions from the sleepy exterior. Because PNB Gilts must hold some kind of a record when it comes to employee profitability. Last year the firm's per employee profits were Rs 3.83 crore (Rs 38.3 million) before tax.

That was up from Rs 2.31 crore (Rs 23.1 million) before tax per employee the year before.

And, what's the total wage bill for PNB Gilts?: Rs 1.45 crore (Rs 14.5 million).

"Our total cost of manpower was less than one dealer in some MNC banks," says Kaul.

But this has been a record-breaking week for the debt market -- which comprises government securities or G-secs and bonds. India's rising foreign exchange reserves is combining with a slew of other factors to create an excess of liquidity that is finding its way into the debt market.

The debt markets also took off after Reserve Bank of India officials indicated recently that interest rates could fall further. For G-sec traders, the going is always good when interest rates fall.

The result has been a week of extraordinary activity. For the first time in recorded memory yields on 10-year G-secs have fallen to around 6 per cent (it was around 8.8 per cent earlier this year).

As a result the market has gone berserk with volumes topping Rs 10,000 crore (Rs 100 billion) as compared to average daily trades of Rs 5,000 crore (Rs 50 billion).

Kaul admits that the market could be getting a bit too volatile for health. But he, like the other market players, has learnt to ride the ups and downs. As its operations have expanded, PNB Gilts' profits have climbed meteorically. In 2001-02 profits after tax soared to Rs 112 crore (Rs 1.12 billion).

That was up from Rs 47 crore (Rs 470 million) in 2000-01. Says Kaul: "In the last two years, the G-sec market has thrown opportunities for making returns upwards of 30 per cent. Where else can you earn such returns?"

That's a sideswipe at the equity markets which have been down in the dumps during the same period. Market analysts reckon that this year could be record-breaking for profits.

How did Kaul and PNB Gilts get to this position in the market? The story started innocuously back in 1996 when the Reserve Bank of India decided that needed to take steps to expand the debt market.

One step taken was to appoint primary dealers who would buy and sell G-secs and bonds and make the trading process easier.

PNB Gilts was one of the six primary dealers who got into the market. Kaul and most of the other staffers were deputed to the new company from the Punjab National Bank's treasury operations.

The new organisation started with Rs 50 crore (Rs 500 million) in its kitty from its parent. But it repaid the money in the form of 20 per cent dividends in about three years -- much quicker than might have been expected.

The bank also raked in more cash when PNB Gilts became the first primary dealer to go public in July 2000.

PNB Gilts' net worth after six years of operations stood at Rs 435.16 crore (Rs 4.351 billion) on September 30, 2002. Post-IPO, PNB's stake in its gilt subsidiary was reduced to 74 per cent.

The debt market has also changed enormously since 1996 when PNB Gilts and the other primary dealers first began trading operations.

Back in 1995-96 the secondary market was a minuscule Rs 30,000 crore (Rs 300 billion) annually.

The secondary market soared to Rs 11 trillion in 2001-02. Total turnover in the gilts market has clocked a turnover of Rs 24 trillion in 2001-02, which is more than the combined volume of equity trades in the National Stock Exchange and Bombay Stock Exchange.

And is set to cross the Rs 30 trillion mark this fiscal. In 2001-02, PNB Gilts achieved a turnover of Rs 1,000 billion. In the current financial year, it hopes to at least exceed this.

The booming debt market has enabled the government to borrow more, at better terms and for longer periods.

In this high stakes game PNB Gilts seems almost like a Nehruvian anachronism. But make no mistakes about the commitment of its employees.

Kaul and his chief lieutenants start talking on the phone by about 7.30 each morning soon after reading the newspapers and figuring out the market moving events.

The traders are in place by 8.45am when the markets open. Activity continues till late at night. Kaul, at his desk is constantly signing trading slips to endorse the moves made his men.

In comparison with the multinational banks an organisation like PNB Gilts is certainly a low wage island even after bonuses to ensure employee loyalty.

But it seems to have kept most of its staffers even during the most volatile times. During the last eight years it has lost only 14 employees and out of that two left to get married. Another two went off for higher studies.

Only three or four have joined rivals. Kaul attributes its low attrition rate to the working conditions and the fact that it called in human resource consultants two years to make sure that it was doing things right.

Says Kaul: "All the recommendations of the consultant, including those on compensation packages, have been implemented," he says.

Certainly, the company has tried hard to look after its employees. The company doctor visits the office twice a week and blood pressure checks are carried out regularly.

"This is a very high tension job. Even some of the youngsters have high blood pressure," admits Kaul.

The company is also looking at different ways to grow. Retail investors have not been PNB Gilts' focus segment till now and its major clients are charitable trusts, co-operative banks, regional rural banks and provident funds.

But now the company plans to attack the retail segment too by leveraging the branch network of Punjab National Bank.

Besides HR, the nature of the business exposes PNB Gilts to portfolio risk.

Here too, according to Kaul, the portfolio is so managed that at the end of the day, only the top 10-15 most liquid securities in the market are retained. Its portfolio research enables dealers to check the efficiency of their trades (the price at which they bought securities compared to competitors).

The company has put in place strong risk management systems including a cut-loss policy (sell securities if losses exceed a certain level) and strict counter party exposure limits. It is also the first primary dealer to achieve ISO 9002 certification for having put in place proper systems and procedures.

Nevertheless, there are risks ahead. One problem is the lack of diversification. In the last six years, PNB Gilts has focused exclusively on trading in government securities. It has remained a plain vanilla primary dealer. To increase visibility, it tapped the capital market in July 2000.

But now it has bigger plans for the future. "Our aim is to eventually become an investment bank offering a host of services to our clients," Kaul says. PNB Gilts has already received a nod from the RBI to let its parent PNB reduce its holding in the company to below 50 per cent.

"We are talking to prospective strategic partners," says Kaul. The idea is to penetrate new markets with the skills, technology and funds that the partner brings along, he adds.

Even though talks are on with various suitors, Kaul is not in a great hurry because the company has huge reserves to take care of its capital needs.

The company also is making a slow entry into the corporate debt market which is small today. Against average trades of Rs 6,000-8,000 crore (Rs 60-80 billion) a day in the G-sec market, the turnover in the corporate bond market is just Rs 300-400 crore (Rs 3-4 billion).

Kaul, however, expects it to grow rapidly over the next few years.

There have been blips in the PNB Gilts track record. Two years ago profits dropped when the market turned tough. And earlier this year it had a bad first quarter when the market turned difficult because of the Indo-Pakistan stand-off. But, considering the amount of money that is being traded daily that's still an amazing record.

Until a year ago the employees would hold a small celebration every time profits crossed a crore daily. This year they've stopped celebrating for such small amounts. Nevertheless, there should be many more celebrations ahead.

Cashing in on bonds

It's raining money for the banking sector. That's because the banks' treasury operations are raking in huge amounts of money because bond prices are at an all time high.

The huge liquidity and poor credit offtake has been fuelling the price rally in government securities since October when the RBI reiterated its softer interest rate bias in the busy season credit policy.

The RBI's relentless mopping up of dollars is adding to the excess liquidity because for every dollar it buys, an equivalent amount of rupees gets into the system.

Banks are sitting on a gilts portfolio of more than Rs 530,000 crore (Rs 5,300 billion), up by Rs 100,000 crore (Rs 1,000 billion) from April 2002.

Banks have to keep 25 per cent of their deposits in government securities (this is called the statutory liquidity ratio or SLR). But because of the poor credit offtake, banks have invested close to 40 per cent of their deposits in gilts.

The interest in gilts has not gone unrewarded. The bull run in the government securities market has continued for over two years. In the last one month, bond prices have risen sharply again.

Market participants are however wary of current levels being sustainable. The market is not moving as per fundamentals, but simply driven by the high liquidity in the system.

Many bankers and market participants expect the market to stabilise at current levels, and the last quarter of the fiscal could even see some drop in prices on profit-booking.

One way or another everyone knows that the bull run can't keep going at current levels.

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