)
The central bank's unexpected bond sale last week has fuelled expectations that the market will be hit by more sales in coming weeks, raising concerns in the government that it will have to pay higher yields as it prepares to raise more debt.
An increase in government spending has left India's banking system flush with funds, just as the central bank is scheduled to pass on a yearly dividend to the finance ministry of at least Rs 5,000 crore ($787 million) in August.
To dampen some of the inflationary pressures stemming from excess liquidity, the Reserve Bank of India last week sold Rs 8,270 crore worth of bonds in an open market operation (OMO).
That sparked a 10 basis point rise in the most-actively traded 8.24% 2024 bonds.
"RBI does not want surplus liquidity. The move was because of concerns of structural liquidity (build-up) in the system," said a policy official familiar with the move.
Traders and analysts expect the RBI to undertake more such moves, to drain excess liquidity to stifle inflation.
An official in New Delhi told Reuters, however, that the government was worried by the prospect, as it needs to raise funds to cover its ambitious spending plans.
"We are not questioning the decision or timing of the OMO, but the worry is that yields on bonds are not coming down," said the government official, who requested anonymity as he is not authorised to speak to the media.
CROSSED WIRES
When the RBI cancelled the sale of three out of four bonds at an auction on June 26, traders assumed it was in reaction to rising yields. So when the central bank announced last week's OMO forcing yields up, they were caught by surprise.
Now, they expect more OMOs.
"More OMO could always be on the anvil," said Vijay Sharma, senior executive vice-president, PNB Gilts Ltd in New Delhi.
That raises potential for further upward pressure on yields.
"The OMO is an explicit way to send a signal to the market that the yields may not decline," said Soumya Kanti Ghosh, chief economic adviser with the State Bank of India.
The most-traded 10-year bond yield has risen about 16 bps since the RBI began cutting interest rates in January, but due to the sharp swings in bonds during the second quarter, the yield rose nearly 30 bps.
Commercial banks say the higher yields makes it even harder for them to lower their lending rates and fully pass on the benefits of the RBI's reduction in policy rates.
Traders and analysts said RBI should instead consider making discreet bond sales in the secondary market.
Alternatively, the government could issue cash management bills, or short term papers, to drain excess liquidity, they said.
($1 = 63.5112 rupees)
