Reserve Bank of India (RBI) governor Shaktikanta Das had a straight from the heart message for the bond market – RBI stands ready to use all its instruments in order to provide adequate support to the bond market, but market participants must cooperate, and while views can be competitive, they need not be combative.
The bond market participants gave a hat tip to the governor by bringing down yields. And now, the government can pretty well expect the reminder of the borrowing to be done in a non-disruptive manner and possibly at the same 16-year low average rate of 5.82 per cent, or even lower for reminder of the financial year, notwithstanding some extra borrowings towards the end of the financial year, or by exercising greenshoe options.
While not exactly announcing an open market operations (OMO) calendar for secondary-market bond purchases, the OMO size has been doubled to Rs 20,000 crore in each such operation. The RBI governor also assured market participants in an online message that “RBI will maintain comfortable liquidity conditions and will conduct market operations in the form of outright and special open market operations”.
Tired of the excessive supply, market participants of late had started demanding higher yields. Not bucking under the pressure, RBI in turn devolved four auctions of the 10-year benchmark bond in August and September, and cancelled an outright OMO. At the same time, however, the central bank silently bought about Rs 2 trillion of bonds from the secondary market to prevent the 10-year bond yields from crossing six per cent.
The central bank also announced on-tap long term repo operations (LTRO) of Rs 1 trillion, targeted towards specific sectors. The fund has to be used to buy bonds and commercial papers coming from companies belonging to specific sectors. This will enhance the market liquidity greatly for these companies, as well as boost the corporate bond market mood.
The governor pointed out that in response to ample measures taken by the RBI, “yields in the government securities (g-sec) market, both primary and secondary segments, also need to evolve in alignment with the comfortable liquidity conditions.” The yields act as the benchmark for the financial markets segment for pricing instruments so as to benefit from the easy financing conditions.
The central bank will also now conduct OMOs on state development loans as a special measure in this financial year, in order to contain their spreads over equivalent maturity government securities, as well as to improve liquidity in the SDL market.
Besides, the central bank also allowed banks to continue investing 22 per cent of their deposit base in bonds in the held to maturity (HTM) category till March 2022. This will help the banks to invest more in government bonds without fearing mark to market losses.
Bond dealers hailed the measures.
“The RBI really achieved quite a bit without cutting rates and that is commendable,” said Harihar Krishnamurthy, head of treasury at First Rand Bank.
The 10-year bond yield fell 9 basis points to close at 5.925 per cent, from its previous close of 6.015 per cent. The three-year bond yield fell sharply by 33 basis points to 4.541 per cent.
“The RBI has always stood by the markets as promised, and these measures should be enough to calm the nerves of the investors,” said Jayesh Mehta, head of treasury at Bank of America.
“Banks, in particular, will have no reason to complain. The cost of funds for banks has come down very sharply, and after investing in bonds, they are earning a healthy spread of 2-2.5 per cent. They can now have their increased HTM bond limits at least till March 2022. Even if yields rise a few years later, they can more than compensate for their loss by the upfront income now,” Mehta said.
“For bonds, it is clearly very positive in the short term as long as the OMOs continue,” said Ashhish Vaidya, head of treasury at DBS Bank.
“The market does not have the risk appetite to take continuous bond supply, so the RBI stepping in is imperative and that’s what the central bank is doing in bits and pieces,” Vaidya said.
Mehta expects the bond yields to remain at 5.90-5.95 per cent for the remaining financial year, but yields should ideally drop “much more,” he said.
“Lower inflation forecast for first quarter next year keeps one more rate cut hope alive. But it has to be noted that observations of a good economic recovery may mean we are coming to the end of the rate cut cycle,” noted Krishnamurthy.
The RBI governor took the policy platform to address disconnect between the RBI’s conduct of the debt management, and the expectations in the market. In order for both the parties to have common expectations, Das said RBI has prioritised the orderly functioning of markets and financial institutions, easing of financing conditions and the provision of adequate system-level as well as targeted liquidity.
Furthermore, “the RBI stands ready to undertake further measures as necessary to assure market participants of access to liquidity and easy financing conditions.”
The central bank governor also engaged in some moral suasion in his policy remarks: “Financial market stability and the orderly evolution of the yield curve are public goods and both market participants and the RBI have a shared responsibility in this regard.”
The high borrowing programme for 2020-21 has been necessitated due to the exigencies imposed by the pandemic in the form of the fiscal stimulus and the loss of tax revenue, Das reminded the market participants.
“While this has imposed pressures on the market in the form of expanded supply of paper, the RBI stands ready to conduct market operations as required through a variety of instruments to assuage these pressures, dispel any illiquidity in financial markets and maintain orderly market conditions,” Das said, adding, the market participants, on their part, “need to take a broader time perspective and display bidding behaviour that reflects a sensitivity to the signals from the RBI in the conduct of monetary policy and debt management.”
We look forward to cooperative solutions for the borrowing programme for the second half of the year. It is said that it takes at least two views to make a market, but these views can be competitive without being combative.