RBI move to keep yields low shakes bond mkt, leaves participants perplexed

Participants complain RBI hasn't done much to help alleviate stress in market

The Reserve Bank of India’s (RBI) market interest rate stance and signaling method is leaving the bond market perplexed.
 
It is making those who do not have enough capital to absorb losses nervous should yields start moving up in a year or two. 
 
The central bank has devolved 10-year bond issues — worth about Rs 58,500 crore — for the fourth time in a row and also cancelled outright  (OMO) of Rs 10,000 crore.
 
Previously, it also rejected bids in special OMOs. The devolved amount is being picked up by primary dealers, the underwriters of the government bond auction.
 
They are buying the 10-year bonds at the cut-off yields of 6 per cent. The yields are already at their decade low and will surely start rising before the bonds mature.
 
If this trend continues and primary dealers are not able to square off these bonds, they will face huge losses. Some could even see big stress in their operations, say executives in these firms and other bond dealers. 
 
The RBI’s penchant for keeping yields soft is understandable. As the government’s debt manager, the RBI has to manage a government borrowing programme of Rs 12 trillion, and also facilitate the states to borrow cheaply.

 
But market participants have started complaining that beyond liquidity support, the central bank has not done much to help alleviate stress in the market. 
 
Sure, there were some measures taken, such as allowing banks to invest more in bonds by tweaking the mandatory ratios – and putting on ample liquidity support.
 
However, the central bank is silent on its sustained OMO support, a long-standing demand of the market. Some of the impatience is now showing and not for long can the central bank expect cooperation from the bond market.
 
“Essentially, there is a ‘fatigue’ among market participants who have been buying bonds relentlessly over the last few months,” said Badrish Kulhalli, head of fixed income at HDFC Life Insurance. 
 
When the government had announced sharp increase in the current year’s borrowing in May, the market had penciled in strong support from the RBI in helping absorb the huge supply.
 
That formed the basis for buying bonds continuously, in the face of enhanced supply, with very little hardening of yields in the process. 
 
But, “now, the markets are looking to RBI to absorb a greater amount of the supply. In such circumstances, the cancellation of OMO does cause some confusion,” said Kulhalli. 
 
However, conditions in the bond market remain conducive.
 
“There is uncertainty in the bond market, and continuous devolvement is not helpful. Otherwise, the conditions are conducive for the bond market – inflation will soften because of the base effect. There’s ample liquidity, and growth is unlikely to come back fast. It would prompt investors to buy bonds.
 
Supply-demand dynamics are the biggest concern now,” said Gopal Tripathi, head of treasury at Jana Small Finance Bank (Jana SFB). But the bond market is still holding on, notwithstanding the devolvement, “as it is waiting for details of the second half borrowing calendar for further cues,” said Hemal Doshi, vice-president, treasury, SBI DFHI, a primary dealer.
 
What has confused the market is that the auctions have been cancelled for a few basis points, and sometimes even at lower than the market rates. However, observers say that the central bank is perhaps compensating primary dealers in a different way.
 
To start with, the RBI nowadays gives underwriters a higher commission. Primary dealers now get 16.97 paise per Rs 100 for the 10-year bonds. A year ago, the underwriters received just 1.49 paise per Rs 100 for auction of a bond maturing in 2033.
 
Therefore, there is a huge jump in underwriting fees.
 
Besides, observers say, to allow primary dealers square off their portfolio, the RBI also does anonymous bulk buying from the secondary market.
 
The buying is also through announced special OMOs. In any case, this is also yield management in the secondary market and yields are not allowed to rise to reflect the actual market conditions. The support for primary dealers, anyway, is just not enough, they felt. 
 
“Despite higher underwriting commission, primary dealers are unable to make money as demand for bonds is far less due to the quarter end and because of uncertainty in borrowing numbers. The on and off secondary market purchases by RBI is not helping the market,” said Devendra Dash, head of asset-liability management, AU Small Finance Bank.
 
The central bank is targeting the 10-year segment as it is the most-traded and a marquee bond considered to be the signaling rate for the market.
 

 
But the prestige of the 10-year bond is also damaged with the government retiring the benchmark in just three months of its issuance, replacing it with another 10-year bond. 
 
Bond dealers say a few basis point movements perhaps do not hurt the government over a 10-year period.
 
But by not letting the markets function normally, the central bank could be damaging them in the long run when India is trying to get into global bond indices. 
 
In this environment, “an estimate of RBI’s potential support in this large borrowing programme and guidance on revenue shortfall by fiscal authorities would take away most of the uncertainties. It will help the bond market,” added Tripathi.