Mumbai: The bond buyers’ strike continues.
A day after the Reserve Bank of India (RBI) had to cancel two auctions of treasury bills after investors demanded higher interest rates on them, the Indian central bank said on Thursday that it managed to attract buyers for less than one-fifth of the Rs.12,000 crore of government bonds it had wanted to sell as part of its recent moves to reduce liquidity.
RBI had earlier this week said it would restrict overnight finance to banks as well as sell bonds in a bid to restrict liquidity in the system, a move that would take pressure off a weak rupee. This has pushed up interest rates in the domestic money market.
However, to provide liquidity to the mutual funds (MFs) industry, the central bank on Wednesday opened a special three-day liquidity window for the industry to borrow. So far, MFs have not made use of this special lending window, indicating the redemption pressure on the industry may not be as acute as feared.
However, the drying up of liquidity in the money market has manifested in a clash between bond investors and RBI, with the former asking for higher yields (and thus offering lower prices for the bond on offer), which the central bank is not ready to accept, as the liquidity tightening measures are temporary.
If RBI starts accepting higher yields at auctions, it might push up interest rates in the market permanently and, among other things, make the government’s borrowing programme costlier. The government plans to borrow Rs.5.79 trillion from the market of which Rs.3.49 trillion is slated for the first-half ending September.
RBI could only sell bonds worth Rs.2,532 crore in the secondary market on Thursday as part of efforts to drain liquidity from the banking system.
The original plan was to sell Rs.12,000 crore of bonds under the so-called open market operation (OMO), under which the central bank controls liquidity in the system through bond purchases and sales in the secondary market.
Bids totalling Rs.24,279.20 crore were received against the bonds on offer, RBI said in a release on its website.
“As long as liquidity remains tight in the system, it doesn’t make sense to bid low yields. By rejecting bids, RBI is sending signals that these measures are temporary,” said Devendra Dash, a senior bond dealer with Development Credit Bank Ltd.
However, for the papers that RBI managed to sell, the central bank accepted bids at higher yields than the prevailing market rates, indicating its acknowledgement of the market reality that in the absence of comfortable liquidity, it will have to be content with selling bonds at higher yields.
“Market also interpreted it as a signal that RBI may hike cash reserve ratio (CRR) in the next policy and remove further liquidity,” Dash added.
RBI will announce its first quarter monetary policy on 30 July, with economists expecting policy rates to remain unchanged at 7.25%. CRR is the portion of deposits that banks have to keep with RBI in cash without any interest, and is currently at 4%.
MF industry officials, meanwhile, added that after Tuesday, redemptions have slowed.
“Fund houses have not felt the need to go to RBI to borrow money to meet their redemptions. The real redemption pressure was there only on Tuesday. Yesterday and today there has hardly been any redemption pressure on mutual funds,” said a chief executive officer at one of India’s top five fund houses on condition of anonymity.
In simple words, fund houses have been able to repay investors by selling underlying securities to meet the sudden gush of redemptions that took place on Tuesday. Tentative figures from MF industry officials showed that banks and institutions withdrew almost Rs.35,000-40,000 crore on 16 July. Of this, banks were said to have withdrawn the most, followed by institutions, as RBI had, through its move on Monday, made it expensive to borrow money in order to curb speculation in the currency market.
Thursday’s bond auction results showed that RBI managed to sell Rs.777 crore of a bond maturing in 2026, which is also the highest traded bond in the secondary market and Rs.1,755 crore of a bond maturing in 2030, a relatively lesser-traded bond. The cut-off for these bonds was 8.2343% and 8.5444%, respectively.
The 2026 bond had opened at a yield of 8.1965%, while the cut-off in the auction was about 4 basis points higher. After the results, the bond rallied and closed at a yield of 8.0965%. As yields fall, prices for bonds rise. Similarly, the 2030 bond opened at 8.5119% and closed the day at 8.3676%.
As part of OMO, so far RBI has been buying bonds to aid liquidity, but on Monday it had said it will be selling bonds instead to suck out liquidity from the system. This was in addition to capping banks’ overnight borrowing limit to Rs.75,000 crore at the repo rate of 7.25%. Any additional borrowing by banks will have to be done at a steeper rate of 10.25%, RBI said.
Thursday’s failure to sell all the bonds on offer follows the cancellation of a Rs.12,000 crore treasury bill auction by RBI, which it had to reject as the market demanded higher yields. RBI could not sell bonds with a shorter maturity for this reason. It cancelled all bids for a bond maturing in 2017 and another maturing in 2022.
Yields on the 10-year bond fell for the second day in a row to end at 7.9905% from 8.052% on Wednesday. The rupee closed at 59.68 a dollar, against 59.34 a dollar on Wednesday.