Mumbai: Yields on the government bonds fell sharply on Wednesday, on the Reserve Bank of India’s (RBI) assurance late on Tuesday, after the market closed, that it would be conducting open market operations (OMOs) to ensure that the government’s additional Rs46,000 crore borrowing programme before 31 March does not face any problem.
Centre stage: The Reserve Bank office in New Delhi. Harikrishna Katragadda / Mint
Through OMOs, the central bank buys or sells government bonds in the market. This time around, RBI plans to buy bonds from the market through auctions, and it will start the process on 19 February. The auctions for fresh government borrowing will start from 20 February.
The yields on the most traded 8.24%, nine-year bond, which was the benchmark 10-year paper in 2008, fell to an intra-day low of 6.25%, from its Tuesday’s close of 6.49%, on a Rs2,700 crore volume. It closed at 6.30% on Wednesday.
According to bond dealers, RBI’s latest move will ease the pressure on the market, which was witnessing a rise in yields since January. They also expect the easing to continue at least till the end of this fiscal year.
Although RBI buys from the secondary market occasionally, buying government paper through auctions is not something it does too often. It will be doing this after a gap of at least five years, dealers said.
RBI can offer higher price, or lower yields to buy back the existing bonds, to signal movement of interest rates. This will bring down the borrowing cost of the government. Prices and yields move in opposite directions.
RBI is yet to spell out the quantum of the bonds it wants to purchase and what kind of securities it will buy from the market. It also has the option of buying anonymously through its order-matching platform.
By the end of this fiscal year, the government would have borrowed Rs2.60 trillion from the market against its budgeted estimate of Rs1.45 trillion. Last year, it had borrowed Rs1.82 trillion.
Apart from bringing down the yields of the existing bonds and making it cheaper for the government to borrow from the market, the open market operation will also help RBI normalize the yield curve, which is very steep now.
The difference between the longer tenure 30-year paper and the 10-year paper is more than 120 basis points now, which according to bond dealers is “almost unheard of”. Ideally, the difference should be 50-60 basis points, they said. One basis point is one-hundredth of a percentage point.
“The open market operation achieves many objectives at one go. It’s an interest rate signal, but more than that it signifies liquidity management, securities management and yield curve management,” said Srinivasa Raghavan, head of treasury at IDBI Gilts Ltd, a firm that buys and sells government bonds. “In a falling interest rate scenario, this much of difference in yields should not be there. RBI will probably buy longer tenure papers to bring the yields down and make it cheaper for the government to borrow because government needs long-term funding.”
According to some dealers, the yields on bonds could have been much lower on Wednesday even after the government’s announcement of its intent to borrow Rs46,000 crore more and concerns of oversupply, had RBI spelt out the contours of its proposed OMOs.
“The yields would have fallen more today, but some uncertainty over the OMO operation and the quantum of RBI borrowing is preventing it from falling significantly,” said Joydeep Sen, vice-president (advisory desk) at BNP Paribas Wealth Management. According to him, the yields on the 10-year paper, which closed at 5.88%, is unlikely to fall below 5% this fiscal year, but would reach that level in the next one.
The higher amount of borrowing is also very unlikely to spook the market not only because of RBI intervention, but also the fact that higher borrowing would mean higher spending by the government, given that the general election is round the corner.
“The market would get back the money sooner than expected,” said Harihar Krishnamurthy, head of treasury at Development Credit Bank Ltd.
IDBI Gilts’ Raghavan expects the the yields on the most traded 8.24%, nine-year bond to fall to 5.75% and the 10-year bond to fall to 5.5% even if RBI decides against any immediate rate cut. Most of the bond dealers are expecting a rate cut and if that happens, bond yields will fall further.