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RBI sets stage for seamless govt borrowing but bond market is not buying fully

In his morning virtual address, RBI Governor Shaktikanta Das set out to soothe the bond market and also dispel some “misconceptions on liquidity. (MINT_PRINT)Premium
In his morning virtual address, RBI Governor Shaktikanta Das set out to soothe the bond market and also dispel some “misconceptions on liquidity. (MINT_PRINT)

  • To help the bond market swallow the borrowing, the central bank has extended the concessions it gave on held-to-maturity portfolio for banks by another year and has said it would use all tools available in its arsenal to manage liquidity

The central government’s banker has pulled out all stops to ensure that it is able to borrow 12 trillion from the markets without breaking a sweat in FY22. The Reserve Bank of India’s (RBI) message today centred on soothing the bond market over liquidity, asking citizens to buy bonds directly from it and giving a benign outlook on retail inflation.

Bond investors had got a rude shock from the Union Budget where the government announced a higher-than-expected gross market borrowing along with a fiscal deficit estimate of 6.5% of gross domestic product (GDP) against an expectation of about 5.5%. Bond traders drove up yields that surged 20 basis points after the budget. One basis point is one-hundredth of a percentage point. Since then the 10-year benchmark bond yield has stayed above 6%, a level that the RBI had painstakingly protected earlier.

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In his morning virtual address, Governor Shaktikanta Das set out to soothe the bond market and also dispel some “misconceptions on liquidity". He said the liquidity stance remains accommodative and pointed out that restoration of variable repo auctions should not be read as change of this stance.

To help the bond market swallow the borrowing, the central bank has extended the concessions it gave on held-to-maturity portfolio for banks by another year and has said it would use all tools available in its arsenal to manage liquidity. To be sure, cash reserve ratio (CRR) would be restored back to 4% as per schedule. But this too is staggered with the restoration divided into two time periods rather than at one go. As such, the CRR restoration is aimed at keeping short-term rates from veering significantly away from what the RBI considers appropriate.

Nevertheless, the bond market didn’t seem to like this restoration one bit. Yields rose about 11 bps after the release of the policy. The reason is that bonds are fungible. Bond investors borrow from the overnight market to invest and benefit from the spread. With the CRR restoration, the overnight rate and other short-term rates would move up. A whiplash effect on long-term yields cannot be wished away. Another grouse of the bond market has been the absence of any clear guidance on the RBI’s bond purchases. Bond investors have been hoping that Das would promise to buy more than what the RBI has been so far through open market operations. But at best, Das sounded cryptic as usual. That said, in a media interaction deputy governor Michael Patra said the impact of the CRR restoration would be replenished through other routes. This portends higher frequency of OMO bond purchases.

For now, the bond market is miffed with the immediate reduction in liquidity surplus. But the market is unlikely to stay so in the coming days. Governor Das certainly hopes that sentiment would turn around. The question now is whether the 6% yield on the 10-year benchmark bond is still the level that gives comfort to the RBI.

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