RBI Keeps 10-Year Bond Yield In Check But Borrowing Costs In Other Segments Rise
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RBI Keeps 10-Year Bond Yield In Check But Borrowing Costs In Other Segments Rise

High government borrowings and the expectation that a rare savings glut will reverse next year pushed up benchmark 10-year bond yields sharply in the days after the budget. Till the Reserve Bank of India stepped in to signal that it will conduct large-scale open market operations and hold the benchmark bond yield at near 6%.

The central bank’s efforts worked with the 10-year bond yield now trading back at near 6.02%. This, despite a rise in global bond yields which are reacting to rising commodity prices.

Beyond the 10-year central government bond, however, interest rates are rising across many segments.

Central government bond yields in the two-, three- and five-year buckets have risen by 69, 85 and 74 basis points, respectively since Jan. 1, compared to much lower 15-basis-point rise in the 10-year yield.

"Even as the RBI is optically trying to manage the 10-year bond yield, the other parts of the curve are showing the impact of a very high supply and eventual normalisation," said Arvind Chari, chief investment officer at Quantum Advisors.

Short-term costs first rose when the RBI announced a resumption of variable rate reverse repo operations at the start of the year. They have continued to inch higher since then. While the RBI will reverse a 100-basis-point cut in the cash reserve ratio announced last year between March and May, it has assured of comfortable liquidity via other means such as open market operations.

To be sure, some rise in short-term rates is desirable to avoid excesses emerging out of a liquidity glut.

State Borrowing Costs Rise

Along with shorter tenor central government bonds, yields on state government securities have also risen.

On Tuesday, weighted average yields rose for 10-year state development loans rose 7 basis points to 7.03%, according to a note by ICRA Ltd. The spread between the central government 10-year bond and weighted average 10-year yield on state development loans stood at 101 basis points compared with 88 basis points last week.

In the case of 5-year state government bonds, the weighted average yields rose to 6.21% from 6.14% last week. At current levels, five-year state bonds are trading at a spread of 43 basis points over the central government's 2026 bond.

State governments and two Union Territories have raised Rs 6.67 lakh crore during April 1-Feb. 16, FY21, a year-on-year rise of 35.1%. Nearly 74% of the increase in SDL issuance has been led by Maharashtra, Karnataka, Tamil Nadu, Rajasthan, Telangana, Andhra Pradesh and Madhya Pradesh.
ICRA Report (Feb. 16)

While the RBI is protecting the government bond market, the supply is high everywhere else and the state government yields are reflective of the significant amount of supply that is coming in at the long end or the 10-year state government bond curve,” said Chari.

“So, the RBI is definitely not being able to have an impact across the government bond market, and rightly so as certain amount of market adjustments will happen as the economy normalises to pre-Covid levels and the other market segments will start pricing it in,” he said.

Mixed Signals From Corporate Bond Market

The corporate bond market, however, may still see reasonably steady borrowing costs. One reason for this is that as risk appetite returns, the additional interest sought for investing in lower-rated corporate bonds may drop. This would help balance out a rise in underlying benchmark yields.

For now, AAA-rated corporate bonds are continuing to trade close to government bond yields. Spreads are wider for three-year AA paper at 85 bps and three-year A paper at 268 bps.

Spreads are wider for five-year AA paper at 93 bps and five-year A-rated paper at 282 bps, while the five-year AAA rated corporate bonds are trading at a spread of 21 basis points over the central government's 2026 bond on Feb. 16,

“Right now, there is hardly any appetite for AA- and A-rated corporate papers that are still trading at yield spreads between 80 to nearly 300 basis points over the government benchmark yields, as investment flows have not yet normalised,” said Ajay Manglunia, managing director and head of institutional fixed-income at JM Financial Products.

“But the market will be keen to see for how long RBI is able to keep the 10-year benchmark yield near 6%, as once the risk appetite returns over the next few months and flows normalise, the yields for lower rated papers may fall closer to benchmark, negating the overall impact of rising government bond yields,” he added.

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