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When it comes to bonds yields, RBI cannot have the cake and eat it too

In a bid to clean up election funding, the government had in January introduced electoral bonds that can be bought from specified branches of State Bank of India and used to donate money to political parties. Photo: iStockphoto
In a bid to clean up election funding, the government had in January introduced electoral bonds that can be bought from specified branches of State Bank of India and used to donate money to political parties. Photo: iStockphoto

So far in FY21, the central bank has bought Rs3.0 trillion worth of bonds, either through auctions or secondary market purchases. Indirectly, it has absorbed a quarter of the government’s borrowing programme of Rs12.8 trillion

Four months ago when central bank governor Shaktikanta Das sought “cooperative solutions" from the bond market, the intent should have been clear. The Reserve Bank of India (RBI) wanted bond investors to increase their appetite to accommodate the government’s mammoth borrowing programme. It also wanted them to do so at a cheaper cost.

In short, Das wanted to have the cake and eat it too. It wants government bond supply to go through and also wants prices to not fall or yields to not rise. It should not surprise us that the plan is not working out well. The benchmark 10-year bond yield is way above 6% currently, a level at which RBI was trying to keep bonds at a few weeks ago. Analysts at Crisil Ltd expect the 10-year bond to touch 6.5% by March 2022 while some in the bond market believe the 6.25% level is not far off. The 10-year bond yield ended at 6.17% on Tuesday. “Overall, we believe, supply pressures will have a bearing on the 10-year G-sec yield once the RBI starts unwinding its ultra-accommodative monetary policy stance," said Crisil analysts in a note.

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The supply of bonds is huge, and simple economics will tell us that when supply exceeds demand, prices fall. In the case of bonds, yields go up as they move inversely to prices. Simply put, the larger the bond supply, the higher the yields will climb. RBI is hoping to bend this logic a bit by participating as a buyer. So far in FY21, RBI has bought 3 trillion worth of bonds, either through auctions or secondary market purchases. In doing so, it has absorbed a quarter of the government’s borrowing programme of 12.8 trillion.

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But unlike in the past, the borrowing itself is huge this financial and the next financial year as well. Ergo, it is futile for RBI to stand in as a big bond buyer for long especially when it has begun normalization of liquidity. Other indirect signals on yields through auction cutoffs and operations twists are effective but only for a short while. The odds of bond yields rising from here on are piling up. India’s banks are readying to lend more to the private sector and credit growth is expected to pick up. They will have less incentive to keep buying government bonds. Retail inflation outlook looks unfriendly with sticky core inflation and rising fuel prices. Moreover, globally bond yields are rising and Indian papers cannot be an outlier. Then there is supply of bonds from state governments. States have already borrowed close to 6 trillion from the market and may end up borrowing another 1.59 trillion.

RBI will have to contend with higher bond yields or risk getting deeper into yield management. The central bank’s interventions are big distortions in the market and a risk to financial stability. As a custodian of financial stability, RBI will need to reduce its footprint in the market. As a banker to the government, it would simply have to ask the Centre to cough up the price.

To be sure, some analysts feel the central bank should not let go of bond yields. Soumya Kanti Ghosh, head of research at State Bank of India, said RBI should increase its bond purchases and do more interventions in the secondary market. In a note, Ghosh argued that rising yields would hurt banks as well as corporate borrowers. That said, the jury is still out on the benefits of consistent interventions by RBI. As such, large central bank purchases of bonds in advanced economies has created trouble even in emerging economies. The temptation to tighten its grip on bonds is strong for RBI, but it should be mindful of the price distortions it creates in the market.

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