Bond buyback to keep a check on yields

Yields on government securities are expected to cool in the second half of the current financial year, provided markets secure liquidity support from the Reserve Bank of India (RBI) through a buyback of bonds.

Government borrowing is expected to be higher than planned in the second half of this financial year, owing to a higher-than-targeted fiscal deficit due to last week’s cut in customs and excise duties. According to market observers, this could lead to a demand-supply mismatch in the government securities market and result in rising yields. The government may buy back securities to keep yields under check.

“Fuel price rises would reduce the subsidy burden, but reductions in excise and custom duties would more than offset this benefit to the fiscal position,” they said in a report. There was further risk of the fiscal deficit rising to 5.8 per cent of gross domestic product, unless the government taps other revenue sources, said economists at Standard Chartered Bank.

Yields on the benchmark 7.80 per cent government bond have been trading at 8.25-8.50 per cent since April. The yields may further harden in the second half if government borrowing increases. Economists said RBI is expected to use the open market operations window to buy back government bonds and infuse liquidity in the system.

“Bonds would also be guided by the fiscal scenario, in which we expect fiscal slippage of 100 basis points to take 10-year bond yields to 8.60 per cent in the second half of FY12,” said Deepali Bhargava, economist, ING Vysya Bank. Lower credit off-take may also force banks to deploy incremental funds in government securities. As on June 3, bank deposits grew at a faster pace than bank advances.

The government has borrowed Rs 108,000 crore through long-term bond sales so far this financial year, compared with Rs 125,000 crore in the corresponding period of the previous financial year. The government had planned a borrowing of Rs 4.17 lakh crore for the entire year, of which around 60 per cent was slotted for the first half.

However, the government has increased the borrowing through short-term papers like treasury bills and cash management bills. According to the revised borrowing calendar, the government would borrow Rs 11,000 crore of treasury bills each week, higher than Rs 7,000 crore planned earlier. This had contributed to the liquidity shortage in the system.

Advance tax payments by companies early this month also added to banks' liquidity woes and led to banks borrowing around Rs 1 lakh crore daily from RBI’s repo window in the last week.