The Indian bond market is on a roller-coaster ride. The yield on 10-year government bonds has hardened after the government announced the huge borrowing programme for fiscal year 2022 in the Union Budget 2021.
Bond market cues often reflect in equity markets. After a bull run, the stock market has corrected in recent days, with both the Sensex and the Nifty falling from record highs. What is happening in the domestic bond market and what are its implications? Let’s take a look.
First of all, what is bond yield?
It is the annual return ones gets on a bond. Bond yield and prices move in opposite directions. The government is the biggest issuer of bonds. It issues bonds to raise money to fund expenditure. So, when yields go up, the borrowing cost of the government goes up.
Will RBI’s uniform price auction method help to cool yields?
As part of its efforts to control volatility, the RBI has introduced Uniform price method for Government bond auctions for its February 26 auction. Under the Uniform price method, all successful bidders are required to pay for the allotted Government securities at the auction cut off rate whereas under the multiple price auction, bidders pay at the respective rate they had bid. The RBI has introduced the method after a long gap to control the volatility in the bond market—in the current context to arrest the rise in yields. On February 26, the RBI plans to sell bonds worth Rs24,000.
Okay, so what is keeping the yields high?
The government’s market borrowing target of Rs 12.06 lakh crore for FY22, announced in the Budget, was higher than expected. The borrowing programme rattled the bond market as it meant an oversupply of papers. Though Reserve Bank of India (RBI) Governor Shaktikanta Das assured the markets that the central bank will make sure government borrowings will sail through in an orderly manner, the market wanted a more decisive action.
“Ever since the Budget was announced, which spoke of additional borrowing of Rs 80,000 crore this year and another Rs 12 lakh crore in FY22, the markets have been spooked. The 10-year yield has been increasing,” said CARE rating agency.
What is the RBI stance?
The RBI has assured ample liquidity in the financial markets. But the assurances have not been entirely convincing to the markets. This is because the central bank has already signalled a gradual return to normal liquidity scenario by stating that the Cash Reserve Ratio (CRR) will be reverted to the 4 percent- level in two tranches.
This sent a clear signal to the markets that the RBI has begun the process of unwinding liquidity measures announced in the wake of COVID. In total, the central bank announced liquidity measures worth over Rs 12 lakh crore to support the financial system since the start of COVID.
“The RBI policy did mention that the stance will be accommodative, but the fact that it said that the CRR will revert to the 4 percent level in two tranches, the message was clear. There would be less of QE in the system, even though there was a promise of liquidity,” CARE said.
How has the 10-year G-Sec yield behaved so far?
The 10-year G-Sec (Govt Securities) yield, which was below 6 percent, prior to the Budget announcement, has jumped 10-15 basis points since then. The 10-year government yield is now seen at 6.18 per cent, compared with yesterday’s close of 6.22 per cent. Just before the Budget, the 10-year yield was 5.906 per cent. From that point, yields have jumped to 6.18-6.23 now.
What has the RBI done so far?
The RBI has been aggressive with the Open Market Operations (OMOs). On February 8, it announced plans to purchase government securities for Rs 20,000 crore two days later, as it looked to calm the bond market.
The announcement saw the bond yields that have jumped in the last few days ease to 6.03 percent from 6.07 percent on February 8. Later, the RBI announced OMOs worth Rs 10,000 crore each (simultaneous sale and purchase) on February 25.
Will there be more OMOs?
Yes. The central bank is likely to go for more rounds of OMOs to support the mega borrowing programme of the government. The RBI is expected to announce OMOs this fiscal year, and in the next, to manage the cost of large government borrowings at an acceptable level. Bond dealers said multiple rounds of OMOs, amounting up to Rs 2 lakh crore, are expected until the market finds comfort.
How has the market responded so far?
The OMO announcement has calmed the markets. But there has been a clear disconnect between the market and the central bank on the desired yield levels. There has been devolvement by primary dealers in three out of four auctions as markets insisted on higher yields but the RBI wanted to keep the yield down at the 6-6.2 percent range. Devolvement refers to a situation when the issue gets undersubscribed and the underwriters buy the unsold bonds.
Why is the stock market correcting?
Stock markets are fundamentally driven by sentiments. Multiple factors have influenced the recent dip in stock markets. Hardening domestic yields is one of them. But the main reason is the hardening of US treasury yields and the global sell- off. A sharp jump in global commodity prices is another reason. The markets fear that higher commodity prices will stoke inflation and push interest rates higher.
Profit-taking also happens after a phase of market run, like what happened after the Nifty and the Sensex hit fresh highs on continuous days. All these factors contributed to the correction.
What else is worrying markets?
There is a resurgence in COVID cases in recent days, especially in key states like Maharashtra. Maharashtra, along with a few other states, has given hints of fresh restrictions, including lockdowns. Lockdown is no good news for businesses as supply chains take a hit.
What is the central bank’s dilemma?
According to rating agency Crisil, the RBI will have to keep an eye peeled for inflation amid an expansionary fisc and rising input costs, though, in general, inflationary pressures are expected to remain under control. “As of now, the RBI is not short on ammunition. But it may need to turn back the accommodative tap if inflation pressures rise. Some normalisation of liquidity has already begun,” Crisil said. The RBI is also concerned about easy liquidity fuelling asset-price inflation and destabilising markets, Crisil said.
How is the fiscal situation?
The government is walking a tightrope on the fiscal front. With the private sector on the sidelines, public spending is the only way forward. The government needs resources to fight the pandemic as also to pay up loans and so on. In the current financial year, the government increased the total borrowings by about 54 percent, or Rs 4.2 lakh crore. Originally, the borrowings for FY 21 were pegged at 7.8 lakh crore against Rs 7.1 lakh crore in the previous year. Subsequently, the fiscal deficit -- the difference between the government’s income and expenditure – was projected at 9.5 percent of the GDP in FY 21.
What is the impact of the huge borrowing on interest rates?
When there is an oversupply of papers in the market, typically, prices fall and yields shoot. But, with the RBI an active buyer, this is unlikely to happen. Bond yields are likely to remain low at the 6 percent level as the RBI is likely to buy bonds in the market.
Will the RBI cut rates again?
It is difficult to say. But going by the comments of MPC (monetary policy committee) members, in the minutes of the February 5 policy review released yesterday, the rate setting panel is worried more about the growth situation rather than inflation at this stage.
The Indian economy is expected to contract by 7.5-7.7 per cent this fiscal as per official and private estimates before rebounding in the next fiscal year, aided by a lower base. The MPC has promised to be on accommodative mode as necessary as possible. An accommodative stance is a growth-supporting policy stance, which, in turn, could mean more rate cuts or prolonged pause depending on inflation data.
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