Bond markets ignore RBI's G-Sap largesse on rising inflation; yields soar

Doubts cast about G-Sap effectiveness at a the time when the Covid-19 surge is threatening to halt economic revival in the country

Bond yields shot up more than 10 basis points after the first auction under the much-publicised G-sec Acquisition Programme (G-SAP 1.0), casting doubts about its effectiveness at a the time when the pandemic upsurge is threatening to halt economic revival in the country.

The G-SAP, on the contrary, was supposed to keep liquidity in the markets. The RBI is committed to pouring in Rs 1 trillion in the first quarter in the hope that “bond vigilantes”, a term used by the RBI in its bulletin, will remain calm.

The first auction of Rs 25,000 crore was on Thursday.

“GSAP is no guarantee for keeping yields low, as the RBI did not take enough in the longer end of the yield curve in accordance with market expectations. The markets, therefore, collapsed in price terms,” said Ashish Vaidya, head of treasury, DBS Bank.

The RBI will be auctioning Rs 26,000 crore of fresh bonds on Friday, and the markets may have demanded higher yields for that.

“The market is preparing for that supply absorption,” said Vaidya.

The bond yields had climbed back after the G-SAP announcement. From 6.18 per cent closing in the last fiscal year, it came down below 6 per cent. But after the G-SAP, the 10-year bond yields closed at 6.13 per cent from their previous close of 6.01 per cent.

The RBI poured in Rs 25,000 crore of bonds under the first auction. Of this amount, it bought the benchmark 10-year bonds worth Rs 7,511 crore at a cut-off yield of 6.0317 per cent.

Bond dealers say the markets started demanding higher yields after wholesale price inflation numbers came in much higher than expected.

The wholesale price index spiked to over an eight-year high of 7.39 per cent for March. Such high inflation necessitates high interest rates, which is reflected in bond yields. But the RBI is trying to keep the bond yields low, hoping to make the borrowing cost cheaper for the government, bond dealers say.

Economists have started revising their inflation outlook, and bond dealers are factoring in pressure on the fiscal position owing to the sharp rise in infections.

The 10-year bond yields closed 10 basis points higher than the cut-off at G-SAP and the paper maturing in 2035 went up by 11 basis points after the auction.

“The market is still not convinced and is demanding higher yields. Pressures of government borrowing and high inflation – today’s (Thursday’s) WPI inflation at 7.4 per cent was a major shock,” said CARE Ratings.

“This market will need to be watched as the view of the market is divergent in terms of the direction of yields,” it said.

According to Debendra Dash, senior vice-president at AU SFB, some investors may have gone short in the 10-year bond segment, expecting to cover them in auction on Friday.

“Rise in oil prices and lower cut-off prices in the 10-year have dented market sentiment,” Dash said.