The Economic Times daily newspaper is available online now.

    RBI has potent options to keep yields in check

    Synopsis

    The tug of war between the markets and North Block’s investment banker should intensify amid rising worries about fiscal deficit and the trajectory of inflation, which has breached the upper end of Mint Road’s mandate.

    rbiAgencies
    Retail inflation reading came in above 6 per cent for four straight months.
    Mumbai: The stage appears set for the central bank to dig into its arsenal for more potent measures to cool bond yields after it persistently rejected the demands for higher returns by potential investors in sovereign debt for the third time in a month.

    The tug of war between the markets and North Block’s investment banker should intensify amid rising worries about fiscal deficit and the trajectory of inflation, which has breached the upper end of Mint Road’s mandate.

    While conventional moves such as policy rate cuts and abundant liquidity helped bring down yields sharply in the early days of the lockdown, yields have lately hardened on expectations of the growth momentum reviving through the stage-gated unlocking. “So far, the Reserve Bank of India has been admirably managing the resultant uptick in bond yields by a variety of unconventional measures,” said B Prasanna, group executive, head – global markets and proprietary training group at ICICI Bank. “In two back-to-back auctions of the 10-year bond, it has devolved almost the entire amount on primary dealers, thereby giving a strong yield signal. But more needs to be done in follow-on measures.”

    It already exempted banks from mark-to-market losses by raising the proportion of bonds that could be held to maturity. Other possible actions include increasing open market operations (OMOs), buying directly from the secondary market, or making public the amount of bonds it would purchase to keep the yields in check.

    Last Friday, the central bank devolved Rs 17,970 crore of bonds on the primary dealers (PDs), those who bid in government bond auctions, after they demanded yields in the range of 6.05-6.08 per cent. Before that, it did so in an auction on August 28, devolving 17,984 crore on PDs, rejecting yield demand of 6.18-6.21 per cent.

    Policy rate was cut by 135 basis points since February and liquidity measures injected at least up to 9.5 lakh crores or 4.7 per cent of the GDP under various plans. That pushed yields down to as low as 5.72 per cent in May, but bounced back to 6.22 in August.

    For the RBI, a 6 per cent yield on the benchmark 10-year bonds is the Rubicon.

    On August 14, about a fourth of the Rs 30,000-crore worth of bonds could not find buyers.

    While the central bank believes that 6 per cent is ideal, investors are haunted by inflation concerns that may force the central bank to unwind easy measures, driving yields higher.

    Bond prices and yields move in opposite direction. Despite its accommodative monetary stance, and a contracting economy, the Monetary Policy Committee kept rates steady in its last meet.

    “There is a tussle between market forces and what the RBI is trying to do,” said Vijay Sharma, executive vice president, fixed income, at PNB GILTs. “Market is worried over inflation and fiscal slippage. RBI is trying to manage yields through Operation Twist and devolvement in primary auction. If yields still rise, the central bank may use more ammunition like buying bonds directly from the market, or increase size of Operation Twists.”

    Despite policy rates at record low and liquidity in excess at Rs 3.66 lakh crore, the term premium or the yield differential between the benchmark bonds and one-year Treasury Bill is now at 229 bps compared with 110 basis points a year ago, Bloomberg data compiled by ETIG show.
    At least Rs 60,000 crore worth of operation twists, where RBI simultaneously buys and sells bonds to influence yields, have been conducted this calendar year. But the quantum of further bond sales by the government is worrying investors.

    “Estimating market borrowing is difficult given the uncertainty related to government revenue, expenditure and inflows from non-market sources,’’ said Anubhuti Sahay, economist at Standard Chartered Bank. “In the absence of both a reduction in overall supply and a complete rollover of T-bills, we expect another 3.5-4 lakh crore of central bank support.” Fiscal deficit is likely at 7.1 per cent of the GDP or Rs 14 lakh crore for the central government and 4.9 per cent or 9.6 lakh crore for the states, estimates Standard Chartered. Net borrowing by the Centre so far is about 9 lakh crore compared with a full-year estimate of about Rs 11 lakh crore.

    Yet another worry is the likely RBI moves when inflation is above the 6 per cent upper band provided in the inflation-targeting framework. Governor Shaktikanta Das already signalled that the markets should be prepared.

    “Once we enter the post-pandemic phase, the focus would be on calibrated unwinding of regulatory and other dispensations,” Das said in the Financial Stability Report.

    Retail inflation reading came in above 6 per cent for four straight months. August print will likely come on Monday. Investors argue that even if the RBI manages to average inflation at 5 per cent, the need for a real return to be 100 basis points leads to a policy rate of 6 per cent. If a term premium of 50 basis points is added, the acceptable yield could be at least 6.5 per cent.

    With inflation-targeting mandate and the necessity not to derail recovery, the RBI faces a double whammy. The need to keep liquidity in check may restrict the tools available to it. “While the elevated near-term inflation outlook along with the reasonably hawkish MPC minutes continue to restrict policy rate easing, the RBI is keen to use other tools to avert dislocations in financial markets,” said Upasna Bhardwaj, economist at Kotak Mahindra Bank.




    (What's moving Sensex and Nifty Track latest market news, stock tips and expert advice, on ETMarkets. Also, ETMarkets.com is now on Telegram. For fastest news alerts on financial markets, investment strategies and stocks alerts, subscribe to our Telegram feeds .)

    Download The Economic Times News App to get Daily Market Updates & Live Business News.

    Subscribe to The Economic Times Prime and read the Economic Times ePaper Online.and Sensex Today.

    Top Trending Stocks: SBI Share Price, Axis Bank Share Price, HDFC Bank Share Price, Infosys Share Price, Wipro Share Price, NTPC Share Price

    ...more


    (What's moving Sensex and Nifty Track latest market news, stock tips and expert advice, on ETMarkets. Also, ETMarkets.com is now on Telegram. For fastest news alerts on financial markets, investment strategies and stocks alerts, subscribe to our Telegram feeds .)

    Download The Economic Times News App to get Daily Market Updates & Live Business News.

    Subscribe to The Economic Times Prime and read the Economic Times ePaper Online.and Sensex Today.

    Top Trending Stocks: SBI Share Price, Axis Bank Share Price, HDFC Bank Share Price, Infosys Share Price, Wipro Share Price, NTPC Share Price

    ...more
    The Economic Times

    Stories you might be interested in