(Photo: Reuters)
(Photo: Reuters)

Despite its limited success, RBI needs to persevere with Operation Twist

  • Market participants say that success will come only if the central bank continues with its Operation Twist auctions
  • Reserve Bank of India has done three auctions so far

India’s central bank resorted to an unconventional yield management exercise last month by selling short-term government bonds and buying long-term ones.

Called Operation Twist by the market, the Reserve Bank of India (RBI) has done three auctions so far. The yield curve, which was steep, has flattened, with the long-term borrowing cost for the government coming down. To that extent, RBI seems to have achieved what it had set out to do, even though it has not publicly stated its objective.

Of course, as this column had argued earlier, these steps have distorted the bond market. Even so, the salutary effects on the long-term borrowing cost for private firms cannot be ignored.

The yield on the 10-year AAA-rated corporate bond has fallen by about 10 basis points, taking its cue from the sovereign bond market. Surely, the larger objective to bring down long-term costs for the industry seems to have been achieved to some extent.

So, can Operation Twist be termed as a success?

Yes and no. Borrowing costs have come down, but private companies hardly borrow from the 10-year and above maturity. More than 60% of the borrowings by private firms are typically up to the tenure of five years. Therefore, the central bank may have missed its mark here.

(Graphic: Santosh Sharma/Mint)
(Graphic: Santosh Sharma/Mint)

“Corporates and non-bank finance companies borrow mostly in the 3-year and 5-year tenure. But, here, yields haven’t really come down and, for AA-rated, there is no respite," said a bond trader, requesting anonymity. Ergo, for a large swathe of borrowers, borrowing costs are still high. But analysts say that RBI may not be comfortable intervening directly in the private credit markets, something that central banks in advanced economies did in the wake of the global financial crisis.

Also, the illiquid nature of the corporate bond market slows down transmission from risk-free sovereign credit to riskier private credit.

Therefore, it all comes down to perseverance by RBI. Market participants say that success will come only if the central bank continues with its Operation Twist auctions. Even for the government bond yield to surmount its fears over fiscal deficit and inflation, RBI will do well to continue with its auctions.

“The real test for the market will come from Budget and the fiscal deficit number. Worries over fiscal deficit and inflation are around. So, continuity is critical here. The RBI should sustain the auctions for, say, three-six months," said R. Sivakumar, head (fixed income) at Axis Mutual Fund.

Perhaps, the central bank will have to increase the amounts of the auctions, too, as Kotak Economic Research said in a note in December.

Of course, for many private sector borrowers, the road to lower borrowing costs will be paved only through fixing their own balance sheets.

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