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Sovereign bonds in India rallied after the central bank stepped up measures to crack down on rising yields following a series of weak debt auctions.

The 10-year government bond yield plunged 18 basis points, the most since May 13, to 5.94%. The rupee rallied 1% in Asia’s best performance after the Reserve Bank of India said that a stronger currency will curb imported inflation.

After weeks of increasingly strident calls from traders for the RBI to act, the central bank on Monday said it will conduct 1.2 trillion ($16.3 billion) worth of repurchase operations and Federal Reserve-style Operation Twists, while relaxing rules on bank ownership of debt. Benchmark bonds had their worst sell-off in more than two years in August after a spike in inflation.

“The RBI is telling the market that when we say whatever it takes, we’ll follow it up with actions whenever it’s required," said Arvind Chari, head of fixed income and alternatives at Quantum Advisors Pvt. “The intent is very clear. The RBI wants yields lower than what they are currently."

Graphic: Bloomberg
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Graphic: Bloomberg

The RBI needs to keep borrowing costs under control with the economy suffering its worst quarterly contraction on record, and the government out to sell a record 12 trillion rupees of debt. The market has been concerned that Prime Minister Narendra Modi’s government will exceed the borrowing targets to revive a virus-ravaged economy.

The yield on the five-year debt also dropped 27 basis points to 5.21% on Tuesday.

New measures:

  • As much as 22% of sovereign notes held by banks won’t need to be marked to market, up from 19.5%
  • RBI will hold two additional Operation Twists this month, totaling 200 billion rupees
  • Central bank will conduct 1 trillion rupees of repurchase operations mid-September to ease any pressure on liquidity due to advance tax payments
  • Banks who had availed funds under LTRO can return the money prematurely and avail it at the now lower repo rate

The new measures “show that the central bank remains determined to keep longer duration bond yields from inching up sharply, as it would have hampered monetary transmission and delayed the ongoing recovery in the economy," said Kaushik Das, chief India economist at Deutsche Bank AG in Mumbai.

The central bank on Friday also sent a strong signal over rising bond yields by setting a lower level than most bids at an auction. It then asked underwriters to pick up nearly the entire benchmark bond on sale.

The new measures are on top of an August announcement to conduct 200 billion rupees of Operation Twists, where it simultaneously buys and sells long and short-term bonds to tame yields.

Banks Purchases

The RBI’s approach to address excess bond supply has been more modest than its high-yielding rival Indonesia, which has waded deep into debt monetization. Still, it has cut rates by 115 basis points in 2020 and conducted discreet secondary market purchases.

Banks may now have room to buy another 3.6 trillion rupees of debt without worrying about price fluctuations with RBI’s rule relaxation, according to IDFC Asset Management Ltd.

“This is a multi-pronged response -- reinforcing forward guidance, extending Twist operations, time bound hike in held-to-maturity limits and allowing banks to reprice LTROs," said Suyash Choudhary, head of fixed income at IDFC Asset. “This clearly puts to rest any dissonance in the market."

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