Mumbai: The Reserve Bank of India (RBI) must buy back more widely held bonds via auctions to prevent a flare-up in yields as early signs of economic revival and demand for loans may dry up surplus cash with banks, traders and investors said.
The federal government has outlined a record borrowing plan for the year and the central bank has been conducting a buyback almost every week to support demand at the federal debt auctions.
A sharp surge in yields, as a result of federal supplies, would undermine the central bank’s easy policy stance by making borrowing costs costlier and choke nascent economic growth.
“The open market operations (OMO’s) conducted by the central bank is more of a symbolic gesture now as liquidity is ample but it will play a major role in the second half of the year when credit picks up,” said A.D.M Chavali, general manger of treasury at Bank of Baroda .
A calendar of debt buyback along the lines of the federal auction calendar would help allay uncertainties, he said, referring to one of the factors that drive yields higher.
However, the RBI bought back fewer bonds than planned at the last four auctions, auction results show.
Traders say that was because the papers it offered to buy were either illiquid or have been previously purchased by banks at a higher cost.
“The choice of papers is very important, by-and-large it has to be an on-the-run paper,” said Prasanna Patankar, senior vice president at STCI Primary Dealership.
“It can’t be a stock where the historical cost is largely decided and then the banks have to book losses by giving it to the RBI,” he said.
At the 9 July auction for instance, the central bank bought only Rs16.61 billion out of a total Rs75 billion tendered via two bonds which traders said was due to illiquidity premium in one and the high purchase price for the other.
With both the government and the RBI scotching any suggestions of a private placement of bonds, senior traders said the RBI will have to step up bond buybacks or resort to other measures such as raising bond reserve requirements.
Banks are currently flush with funds, but stopping the bond buyback may send a wrong signal to the market and cause a sell-off, said A Prasanna, economist at ICICI Securities Primary Dealership.
“It doesn’t matter if in a given week the OMO is successful or not. Given the fact that the RBI is there provides a lot of comfort to the market,” he said.
Overnight rates have fallen close to the reverse repo rate of 3.25% from 17% in October and the RBI has been absorbing over Rs1 trillion a day since 4 April, indicating the huge surpluses in the system.
The government has already raised Rs1.89 trillion out of 2.99 trillion scheduled till end-September.
Against that, the central bank has bought back Rs298.5 billion since April and has pencilled in a total Rs800 billion worth of buy backs by September-end.
For jittery bond investors, the central bank’s policy review will provide the next cue, said Mahendra Jajoo, head of fixed-income at Tata Asset Management.
“The market will watch out for any talk on MSS bonds, open market operations and overall stance on activating the liquidity withdrawal strategy,” he said.