India’s bond market is upset at the hawkish note struck by the Reserve Bank of India (RBI) in the first monetary policy statement of the new fiscal year, which signalled the central bank's intention to begin withdrawal of its accommodative policy stance even as the government sets about its vast borrowing plan. Rising yields would mean government borrowings will be more expensive.
The benchmark 10-year government bond yield rose 21 basis points (bps) to 7.03 percent on Friday after the RBI indicated it would begin to neutralize the systemic liquidity surplus over a multi-year period. Bond prices move inversely to yields. One basis point is one-hundredth of a percentage point.
The RBI also introduced a Standing Deposit Facility (SDF) at a rate of 3.75 percent, which it said would be the floor of the liquidity adjustment facility (LAF) rate corridor. The corridor itself was restored to the pre-pandemic level of 50 bps with the SDF rate as the floor and the Marginal Standing Facility (MSF) rate as the ceiling. The repo rate or the rate at which the RBI lends money to commercial banks, at 4 percent, would continue to be the policy anchor.
In essence, the RBI rendered the reverse repo rate of 3.35 percent irrelevant, and at the same time pushed the effective policy rate 40 bps higher than the SDF rate of 3.75 percent.
“This policy, in some sense, is a Segway to tightening policy rates in the coming months. Expect yields to rise across the curve to reflect the policy stance,” said Lakshmi Iyer, Chief Investment Officer (Debt) & Head of Products, Kotak Mahindra Asset Management Company.
RBI Governor Shaktikanta Das’s statement that the RBI was now putting inflation above growth in its sequence of priorities did not help sentiment in the bond market. “This is the first policy where they have taken a higher priority of inflation versus growth. This is a significant pivot in policy thought process,” said R Sivakumar, head of fixed income at Axis Mutual Fund, adding that repo rate hikes can be expected starting in June.
At around the 7 percent mark, the benchmark bond yield is already near the levels seen before the rate reduction cycle began two years ago. Sivakumar believes that the market is pricing in roughly 100 bps of hikes in the repo rate over a period of one year. As such, some economists expect the repo rate to be raised by at least 50 bps this year.
To that extent, the rise in bond yields from here on may not be significant. Even so, some investors expect yields to rise if successive inflation prints surprise on the upside. “The RBI forecast for inflation is 5.7 percent for FY23, but inflation has always surprised on the upside. So, there is scope for yields to rise if we see higher prints in the coming months,” said a bond trader at a private sector bank, requesting anonymity.
Borrowing hiccups ahead
It is clear that the government will have to pay a higher yield on its market borrowings in the coming months. The Centre will borrow Rs 14.95 lakh crore from the bond market this year, of which Rs 8.45 lakh crore will be borrowed in the first half.
Note that the RBI has been a big buyer of government bonds in the previous years. During FY21, the central bank absorbed Rs 3.13 lakh crore worth of bonds through its open market operations. In FY22, it bought Rs 2 lakh crore worth of bonds through GSAP, or G-Sec Acquisition Programme, but had slowly become a bond seller towards the end of the financial year. Buying bonds again would be contrary to its stance of reducing the liquidity surplus in the current year.
At the same time, the bond supply from the government is large enough to put pressure on yields. In the wake of credit growth picking up, the central bank would be hard pressed to stay on the sidelines and risk the crowding out of the private sector. Iyer of Kotak Mahindra AMC expects the central bank to be tested on its willingness to step in to calm yields if required through bond purchases in order to complete the borrowing plan without disruptions.
To its credit, the central bank said that it is focused on completing the government’s borrowing plan, towards which the RBI will deploy various instruments. In essence, this will keep open the discussion on future bond purchases.
Bond market participants expect the 10-year benchmark bond yield to move in the 7.00-7.25 percent band, but it may rise more, depending on the pace of inflation.
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