 "bond market")
The bond market and the Reserve Bank of India (RBI) have locked horns and are testing each other’s limits.
The oversupply concern is definitely there, but the market participants, on their part, may have turned greedy. But the central bank, by trying to keep yields low and expecting the markets to accept that, is behaving a little unreasonably, say bond market participants.
The 10-year bond yield was below 6 per cent on February 11, but on February 18 when the central bank devolved more than Rs 20,000 crore in a Rs 31,000-crore bond auction, the yields shot up to 6.13 per cent. Friday was a market holiday.
Fundamentally, when the supply of bonds is huge, the prices of the incremental bond supply should fall as demand gets saturated. As bond prices fall, yields rise. However, the central bank wants to keep the 10-year bond yields below 6 per cent, as it did for the most part of the current fiscal year, and with reduced accommodation. And so, the central bank cancels auctions, and then forces the underwriters to buy the bonds if the market demands higher yields. The underwriting commissions, unsurprisingly, have gone up 40 times as a result.
The bond market was expecting some kind of relief measures from the central bank in the monetary policy on February 5. The Centre had announced Rs 12 trillion of borrowing for the next fiscal year, and Rs 80,000 crore extra for the current fiscal year. The central bank could not offer any comment due to the three-day monetary policy meet, and so the expectation was huge that there would be some solid liquidity measures announced five days after the expansionary Union Budget.
According to bond dealers, beyond some oral assurance, the RBI had nothing much to offer. Governor Shaktikanta Das declared low bond yields as ‘public good’. In the past, the governor had urged the bond market to be cooperative without being combative. “The RBI needs to give confidence to the markets. By simply saying that we will support markets and that the yield curve management is for public good, the markets are unlikely to get comfort,” said Ashhish Vaidya, head of treasury at DBS Bank.
According to Vaidya, the bond yields have moved up yet again due to larger supply, overall rising inflation expectations both locally and globally, and the fear in the markets about the RBI potentially exiting large excess liquidity. Even as the RBI has assured ample liquidity, actions such as a timed increase in cash reserve ratio (CRR) and talks of normalisation of liquidity naturally pushed up yields in bonds.
If the RBI does not come up with solid measures in the coming days, “I am not sure if they will be able to hold markets,” Vaidya said.
It is not that the central bank has not given in to market demand. So far, this fiscal year, the amount of open market operations (OMOs) has been more than Rs 3 trillion. Each OMO purchase size has been doubled to Rs 20,000 crore. The central bank allowed retail investors to directly purchase bonds from the secondary market. If this is successful, by next fiscal year, much of the bond market pressure can be eased. By extending held-to-maturity relaxations for another year, a potential Rs 4 trillion space has been opened up. And then, sources say the OMO purchase for the next fiscal year would be at least Rs 3 trillion.
The bond market, according to senior economists, are showing some signs of greed for sure. But bond dealers, on the other hand, argue that they have no issue with a large borrowing programme, but the RBI should not insist on keeping the yields below 6 per cent, when the economy is showing an upswing.
“The trigger has seeds in the ‘normalisation’ of interest rates where Rs 2 trillion was pulled out at 3.55 per cent. That became the short-term floor. Liquidity in markets is coming down and tax in March should be very strong and reduce liquidity further. Large OMOs outright could change move along with removal of 14-day reverse repo auctions,” said Harihar Krishnamurthy, head of treasury at First Rand Bank.
“With unprecedented supply, yields would have to go up. So, the volatility will continue to persist and the RBI will try to keep yields within a range by using every instrument, implicitly or explicitly,” said Soumyajit Niyogi, associate director at India Ratings and Research.
But OMO itself may not be a lasting solution to the present crisis, said market expert R.K. Gurumurthy. “The large devolvement or failure in the two recent auctions are an indication that overwhelming supply concerns are keeping bidders wary.”
However, the RBI does have sufficient instruments to manage the auctions smoothly. But a spike in short-term yields will impact the corporate bond yields.
For now, it seems to be a case of simply an indirect monetisation.
“During times when the RBI intervenes in the market through OMO, special OMOs or secondary market purchases, the supply gets absorbed and bond yields are largely stable. However, during periods when the RBI’s purchases are lower, the supply of bonds increases market volatility,” said Badrish Kulhalli, fund manager at HDFC Life.
The volatility is currently driven by the level of intervention by the RBI, along with other factors like oil prices, US Treasury yields, etc. But the fact remains that the “market appetite for bonds is quite weak and supply of bonds is quite large,” Kulhalli said.
