RBI flags concern over elevated bond yields; OMO unlikely in November

RBI engages with market participants amid widening India-US yield spread; bond purchases unlikely before final CRR cut at month-end

With the spread between 10-year government bond and the comparable US treasury widening close to 250 basis points (bps), the Reserve Bank of India (RBI) seems to have conveyed its discomfort with elevated yields to the market. The central bank is holding a series of discussions with market participants this week and next week.

 

Despite a cumulative 100-basis-point reduction in the repo rate between February and June, the 10-year bond yield has not eased in line with policy rates and has instead inched higher since the 50-basis-point policy rate cut in June. The yield on the benchmark 10-year government bond has risen by 24 basis points since June, while the yield on the 10-year US Treasury bond has fallen by 32 basis points during the same period.

 

The yield on the benchmark 10-year bond currently stands at 6.53 per cent. The yield spread has widened, from about 219 basis points at the start of the year to roughly 244 basis points currently.

 

Last week, the central bank cancelled a 7-year bond auction after the market demanded higher yield, which could have inverted the 7 year and 10-year bond yield curve.

 

During the interaction with the central bank, market participants demanded open market operation for bond purchase which will infuse liquidity and soften yields.

 

While RBI may have intervened through bond purchases on the Negotiated Dealing System-Order Matching (NDS-OM) platform, an electronic trading system that facilitates transparent, order-driven transactions among banks, primary dealers, and mutual funds. However, announcing OMO will be difficult at this point as the last tranche of June cash reserve ratio (CRR) cut is pending, scheduled during the fortnight beginning November 29.

 

The market is now focused on Friday’s auction of the new 10-year bond, worth ₹ 32,000 crore, for further cues. In the last auction on October 3, the coupon was set at 6.48 per cent, and the cut-off yield at the upcoming auction is expected to rise by 3 basis points-4 basis points.

 

The last time the RBI devolved a 10-year government bond, excluding green bonds, was on February 17, 2023. The central bank had devolved ₹8,254 crore of the 7.26 per cent 2033 bond, against the notified amount of ₹12,000 crore to primary dealers, due to weak investor demand.

 

According to dealers, several banks are already sitting on sizable mark-to-market losses, making them reluctant to take additional exposure and prompting a reduction in their SLR holdings.

 

Additionally, market participants have requested that the auctions of state government securities should be conducted using the uniform pricing method in the fourth quarter of the current financial year. The weekly auctions of state bonds are currently conducted via multiple price method.

 

In the multiple price-based auction system, successful bids are accepted based on the quoted yield or price for the security that was specified by the bidder. Under the uniform pricing method, bonds are sold at the cut-off level decided by the RBI.