The Reserve Bank of India (RBI) is not intervening in the currency market alone; it is also actively buying into secondary-market bonds, in addition to its publicly announced auctions under open-market operations (OMO), to bring liquidity into the banking system and cool bond yields.
RBI's 125-basis-point policy rate cut in the 2015 calendar year did not cause a substantial drop in bond yields. The yield on the 10-year government bond, which declined only about 13 basis points in the entire year, has again been rising since early January. On January 29, it closed at 7.783 per cent - higher than the 7.713 per cent a year ago - despite a policy rate differential of 100 basis points (RBI had cut repo rate by 25 basis points on January 15 last year). One basis point is a hundredth of a percentage point.
High yields, acute liquidity shortage and a continued supply of bonds from the central and state governments have rankled the bond market. The yields on those have shot up occasionally, prompting RBI to intervene. A low bond yield is necessary to ensure the government does not end up borrowing at a higher rate.
"The common man does not really care whether we stay on the consolidation path or not. But the bond market, where we have to finance over Rs 10 lakh crore of deficits, plus UDAY state bonds, does care," RBI Governor Raghuram Rajan said on Friday.
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"Deviating from the path of fiscal consolidation could push up yields on government bonds, both because of a greater volume to be financed and the potential loss of government credibility on future consolidation," Rajan had warned in his speech at the National Council of Applied Economic Research (NCAER), New Delhi.
Under open-market operations (OMOs), the central bank buys bonds when liquidity is tight, and sells securities to suck out liquidity when there is abundance. This financial year, through OMOs, the central bank sold Rs 8,270 crore worth of bonds on July 15, but bought Rs 20,000 crore worth of those through auctions on December 7 and January 20.
Between December 7 and January 21, RBI bought Rs 34,610 crore worth of bonds, including the pre-announced OMO purchases, data show.
The additional Rs 14,610-crore bond purchases were done in small amounts, indicating that one or two bonds were targeted. While the central bank does not give segregation of data, bond dealers say intervention happens in the most active papers, such as the 10-year and five-year segments, where a sudden Rs 500-crore bond purchase at a lower yield drags down yields of those bonds as well as others.
In fact, data from RBI's database on the Indian economy show the January OMO of Rs 10,000 crore was not enough and the central bank bought another Rs 510 crore worth of bonds directly from the market. Dealers say it was an intervention to cool off yields.
"There are indications that yields are on the higher side, and RBI is not accepting higher bids in primary bond auctions. Since it is intervening in the currency market and removing liquidity, it is putting back some liquidity through bond buybacks, and trying thereby to bring down the yields," said Devendra Dash, senior bond trader with DCB Bank Ltd.
RBI recently rejected all bids for a Rs 9,000-crore 91-day Treasury bill auction, as the market demanded higher yields.
To stabilise a falling rupee, RBI has in the past month sold about 5 billion of dollars. This has removed an equivalent amount of rupee liquidity from the system. Plus, the government's high cash balance with RBI (of which Rs 1.40 lakh crore was available for auction) has put pressure on the market. RBI does not give the exact figure of the government cash balance but releases data on the amount meant for auction to banks.
"A necessity for infusion of structural liquidity has become more prominent with forex intervention and depletion of net foreign assets. That has to be balanced by addition to net domestic assets. In the current liquidity framework, OMOs (both purchase and sales) have become an indispensable tool," says Soumyajit Niyogi, associate director (credit & market research group), India Ratings & Research.
However, unlike currency intervention, where the central bank uses banks to buy and sell dollars, RBI buys and sells directly from the market in the case of bonds, under the 'others' category.
According to numbers available from RBI's database of the Indian economy, the central bank made the biggest intervention on December 15, of Rs 850 crore. The amount has fallen since to hover around Rs 310 crore and Rs 540 crore on a daily basis in January.