RBI steps in with measures to boost demand for bonds, cool down yields

Says it is comfortable with a rising rupee, which helps bring down import-led inflation, adds that it remains "committed to ensuring comfortable liquidity and financing conditions in the economy"

The Reserve Bank of India (RBI) on Monday stepped in on Monday with a number of measures that would boost demand for government bonds and keep yields under check and improve liquidity in the system. 

The RBI cited impact on market sentiment “by concerns relating to the inflation outlook and the fiscal situation amidst global developments that have firmed up yields abroad.” 

The central bank also indicated that it is comfortable with an appreciating rupee, which helps bring down import-led inflation, and said it remained “committed to ensuring comfortable liquidity and financing conditions in the economy.”  

Stepping in to boost demand for the government bonds, the central bank increased the held to maturity (HTM) limit of banks substantially. In HTM category, banks do not have to mark to market their investments with the current market rates and therefore the banks do not incur any nominal losses.  

 

Currently, banks are supposed to maintain a quarter of their overall bond holdings in HTM category. Banks are required to maintain a minimum of 18 per cent of their deposit base in government bonds, also called statutory liquidity ratio (SLR). Even as the HTM is pegged at 25 per cent of this 18 per cent SLR, RBI allows the HTM investment to rise provided it remains within an overall limit of 19.5 per cent of the deposit base. This 19.5 per cent limit has now been increased to 22 per cent.  

As per RBI calculations, government securities held in HTM category by major banks amount to around 17.3 per cent of their deposit base, while in some cases, it had reached the limit of 19.5 per cent. This extra limit of 2.5 per cent would mean an extra demand of nearly Rs 3.56 trillion, bond dealers say. The fresh acquisitions have to be done with effect from September 1 up to March 31. The relaxations would be reviewed thereafter. 

This would help create extra demand for government’s Rs 12 trillion borrowing programme. The central bank has finished borrowing more than 90 per cent of the first half’s Rs 7 trillion borrowing. The central bank has to also manage a huge borrowing by the states, and possibly extra borrowing by the centre towards the end of the year. 

“The RBI measures are directly aimed at maintaining an orderly market conditions and ensure financial conditions are congenial at all times. The RBI has been saying hammer and tongs that the borrowing program will be non-disruptive which appears to have been achieved by an these announcements,” said R K Gurumurthy, head of treasury, Laxmi Vilas Bank, adding the bond yields may remain “reasonably aligned to macro factors.” 

The central bank refused to sell nearly Rs 18,000 crore of the benchmark 10-year bond on Friday’s auction as investors demanded higher yields. The 10-year bond yields, which has a coupon of 5.77 per cent, had spiked as much as about 6.2 per cent recently. But RBI’s past actions forced the yields to soften and it closed at 6.12 per cent on Monday. 

“The spike in yield has bought to the fore dual role of RBI as monetary policy authority and debt manager for governments. The impact on the yield post the policy, has now been addressed by higher HTM limits,” said Soumyajit Niyogi, associate director at India Ratings and Research.  

Among other measures, the central bank said it would conduct another round of special open market operations (OMO), under which it would simultaneously buy and sell bonds worth Rs 20,000 crore in two tranches. In market parlance, this kind of OMO is called Operation Twist.  

The central bank has already done one such OMO of Rs 10,000 crore and another OMO is due on September 3. As per RBI’s notification, there will be two more such operation twist on September 10 and September 17 of Rs 10,000 crore each. 

The central bank said it will also conduct term repo operations for an aggregate amount of Rs 1 trillion at the prevailing repo rate in the middle of September “to assuage pressures on the market on account of advance tax outflows.” 

The central bank gave options to banks to reverse the funds taken under long-term repo operations (LTROs), to ease their cost of funds.  

 

“Thus, the banks may reduce their interest liability by returning funds taken at the repo rate prevailing at that time (5.15 per cent) and availing funds at the current repo rate of 4 per cent,” the RBI said. 

“HTM will check spike in bond yields, and more operation twists will flatten the curve. Additionally, reversal of LTRO will reduce intertemporal consequences for Banks, and will improve appetite for banks to borrow and park in bonds,” Niyogi said. 

RBI’s take on rupee also piqued the interest of traders. 

“There are indications that food and fuel prices are stabilising and cost push factors are moderating. In addition, the recent appreciation of the rupee is working towards containing imported inflationary pressures,” the RBI said.  

The central bank has of late withdrawn from intervening in the spot currency markets, and let the rupee appreciate to a six-month high, while keeping its forward markets intervention intact.  

An appreciating rupee theoretically makes import cheaper, and therefore controls inflation. It is considered an indirect method of raising interest rates without touching policy rates, which remain in “accommodative” mode.