As part of its regular yearly practice, the government met bond houses on Wednesday to discuss its borrowing calendar for 2018-19. The conditions couldn’t be more unfriendly though.
Bond yields have surged around 100 basis points in the last six months, essentially conveying that investors don’t like them any more. It is well known that foreign investors have begun dumping Indian bonds for a month now and even local banks are wary after choking on losses from previous buying binges.
Forsaken by the biggest buyers, the bond market has seen trading volume dry up and consequent rising yields have wreaked havoc on many a balance sheet.
But who can blame investors for pricing in realities of inflation, a monetary policy poised for tightening and liquidity that is becoming scarcer?
In previous episodes, the Reserve Bank of India (RBI) has typically come to the rescue citing liquidity compulsions. The central bank has been willing to shoulder the burden of supply, partly by buying bonds because there weren’t enough funds in the market to absorb the whole amount. It is no surprise that this time too, analysts are expecting RBI to step in and shoulder some of the weight of the Rs4.07 trillion supply scheduled in 2018-19.
So far, the message from the central bank has been in the negative. But should RBI turn into a buyer as the market would want it to?
There are sound reasons it should not.
Firstly, the central bank has always maintained that its purchases or sale of bonds through open market operations is a liquidity tool and any impact on interest rates is incidental.
The banking system’s liquidity is near neutral now, something that RBI wanted to achieve and has done so through a mix of several measures. During neutral liquidity conditions, what distinguishes corporate credit from government is the credit risk as there are no distortions arising out of the pursuit of yields.
Rising bond yields capture inflationary pressures and there is no doubt that inflation pressures are on the rise and liquidity would be scarce going forward. Also, when yields across geographies are going up, Indian bonds cannot be an outlier. All said, rising bond yields also mean a punishment to a government that has given up fiscal frugality.
If RBI begins to buy bonds, it would mean that the central bank is making good banks’ losses. That is not a regulator’s job. Trading losses are a reality of having treasury operations and managing these is solely in the hands of banks. It would also mean a tacit support to the government’s fiscal profligacy by distorting its cost of borrowing and would go against the current policy stance.
As to the government, it should accept the realities of a higher cost of borrowing.