RBI-Bond Markets Face-Off On Cost Of Government Debt

For the fourth consecutive time, the Reserve Bank of India failed to pull off an auction of benchmark 10-year bonds.

The RBI headquarters in Mumbai. (Photographer: Adeel Halim/Bloomberg)

For the fourth consecutive time, the Reserve Bank of India—debt manager to the Government of India—failed to pull off an auction of benchmark 10-year bonds.

At the latest auction on Friday, Rs 30,000 crore in government bonds was on auction. Of this, Rs 18,000 crore was in 10-year bonds (5.77% GS 2030). Only Rs 136 crore was sold at a yield of close to 6%, which is where the benchmark has hovered for some time now. The rest of the Rs 17,864 crore devolved on primary dealers. The shorter tenor 2022 bond was also not fully subscribed at this auction, although the longer tenor 2060 bond was.

A similar story has played out in previous auctions:

  • On Sept. 11, of the Rs 18,000 crore in 10-year bonds up for auction, only about Rs 30-odd crore was accepted.
  • On Aug. 28, Rs 16 crore was accepted compared to the Rs 18,000 crore on offer.
  • On Aug. 14, Rs 13,362 crore in bids were accepted compared to the Rs 18,000 crore on offer.

In the middle of these regular auctions, there was also an attempt to purchase government bonds under the open market operation programme earlier this week. The RBI intended to buy Rs 10,000 crore in bonds but did not accept any of the bids in the auction.

Also Read: Public Sector Borrowings Up 58% In First Half Of FY21

Holding On To 6%?

These devolvements aren’t common. They typically signal stress of one kind or another.

So what’s going on? A few things.

First, it isn’t as if demand has disappeared. The auctions are still getting bids, but the bid-to-cover ratio has dropped. Also, the bids appear to be coming at a price/yield that the regulator is not comfortable accepting.

At about 200 basis points, the spread between the overnight repo rate and the 10-year is already steeper than long-term averages.

Perhaps the RBI feels that spread adequately captures the inflation scenario and the demand-supply dynamics. It may also fear the outcome if the market smells the central bank’s willingness to let rates drift higher. Where will it stop? And what will the central bank have to do the reign in the upside in yields if the market’s expectation that the RBI will do ‘whatever it takes’ to keep rates in check is shaken.

The market, on the other hand, appears to be signaling that words are no longer enough.

There is increasing concern about the supply of government bonds that will continue to come to market. Not just this year but over the next few years as the fiscal position of the government remains strained. There are also lingering worries about inflation even though the RBI and Governor Shaktikanta Das have publicly tried to downplay those fears.

Between those two concerns, the market appears to believe that a 6% yield on the 10-year does not capture all the risks. The RBI likely believes it does or at least wants the market to believe it does. And hence the stand-off.

Also Read: Government Has More Fiscal Space Than Believed, Says JPMorgan’s Sajjid Chinoy

H2 Is Different From H1

Now, it could be argued that some of these factors were at play even in the first half of the year, when even news of a record high government borrowing programme of Rs 12 lakh crore didn’t send the markets into disarray.

Policy rate cuts, surplus liquidity and the belief that the RBI will ‘do whatever it takes’ allowed rates to fall to decadal lows. The supply of public sector borrowings rose by 58% but was absorbed by the market.

What’s changed now?

One factor certainly is that banks have gorged on government bonds through the first six months and appetite may now be weaning. The statutory liquidity ratio holdings of banks are upwards of 28% compared to the minimum requirement of 18%. Some banks may have also taken mark-to-market hits on some of their bond purchases and that may have dented their appetite as well.

To keep the appetite for government bonds high, the RBI has increased the held-to-maturity limit by 2.5 percentage points from 19.5% currently to 22% now. While the market seemed enthused by the measure momentarily, the excitement disappeared amid the wider concern over the extent of supply coming in.

Along the way, there may have been some ‘lost in translation’ moves.

For instance, the RBI allowed banks to return the funds raised via the long-term repo operations. The central bank’s idea may have been to let banks return relatively higher cost money. But the market saw it as a signal that the RBI may be ready to wind down its extra-ordinary measures and start the process of shrinking its balance sheet.

Similarly, the outright open market operation announced this week came at the end of the quarter and half year. And so, according to a market participant, banks chose to sell bonds from the held-to-market portfolio at a discount to the prevailing market price, in a rare move in order to book some profits. Remember, banks can’t sell bonds held in the HTM bucket in the open market but they can do so as part of open market operations conducted by the central bank. The RBI eventually rejected the bids, leaving the market confused about the signal.

Time To Walk The Talk

The over-arching question, though, remains this: what will the final fiscal situation look like and will the RBI pull the trigger and monetise—directly or indirectly—a part of the government’s borrowing.

The reality is that the second half of the year will still see a lot of supply. States’ borrowings will rise as some part of the GST compensation dues will now come via the markets. The expectation is that the centre may need to stretch the Rs 12 lakh crore planned borrowing by another Rs 2 lakh crore or so. And central public sector enterprises and some large corporates will continue to borrow too.

Just the promise of ‘whatever it takes’ may no longer be enough. The RBI may need to act on its words by either announcing a sizeable government bond purchase programme via open market operations or directly.

Ira Dugal is Editor - Banking, Finance & Economy at BloombergQuint.

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