The central government’s plan to borrow a massive Rs 12 lakh crore in 2021-22 and additional Rs 80,000 crore in fiscal 2021 from the market has spooked the bond market.
Bond investors are seeking higher yields as with the rise in demand the prices should rise.
They see RBI winding back its accommodative measures as the economy recovers from the pandemic. Traders, therefore, see few incentives to buy bonds.
Borrowing costs
However, RBI, the manager of government borrowing, has to keep costs low for the government and is therefore looking at pumping liquidity to ensure yields are capped.
To support the programme, the RBI will seek to buy more than Rs 3 lakh crore of debt while capping the benchmark yield at 6%.
However, the benchmark 10-year bond as its yield keeps breaching 6%, a level that’s seen as a line in the sand for the Reserve Bank of India.
The central bank typically raises funds from banks, financial institutions, mutual funds and foreign institutions. It recently allowed retail investors also in the bond market.
Inflation woes
With the rising inflation, RBI, which operates the monetary policy, is mandated to raise rates to tame inflation. This brings in conflict with its role to keep borrowing costs low for the government.
Experts this conflict rising in the coming years as the government has guided that the fiscal deficit will higher for the next few years.
So how is RBI managing?
As long as inflation is low, the RBI steps in and purchases bonds, but when interest rates start rising, it will have to increase liquidity in the system and push down rates.
The central bank is already resorting to measures such as Operation Twist, or simultaneous buying and selling of bonds via open market operations (OMOs).
It has already conducted Rs 3 lakh crore of bond purchases under OMOs this year.
In Operation Twist, the central bank buys longer maturity papers and sells shorter maturity papers to keep liquidity neutral.
However, as corporates raise money at shorter yield, Operation Twist is crowding them out of the market.
The central bank has also undertaken measures such as long-term repo operations and targeted long-term repo operations to infuse liquidity into the system.
The hitch
However, the market is jittery over such a huge borrowing plan and it also sees certain RBI measures veering from the accommodative stance as inflation rises.
Already, the borrowing programme of the central government for this financial year till date has been of around Rs 13.17 lakh crore and those of state governments around Rs 7.17 lakh crore. All these purchases are reflecting losses on investor balance sheets.
The RBI which had cut cash reserve ratio (CRR) by 100 bps in March 2020 for a period of one year, has recently announced a phased restoration of CRR to 4 per cent from March 27, which is being seen as a move towards reversal of accommodative stance.
The RBI’s strategy of pursuing multiple objectives such as exchange rate management to stop the rupee from appreciation, inflation control and liquidity management has led to confusion in the market.
Due to this the yields remain elevated. The spread of 10-year government bond over the repo rate has remained widened as also the spread of 10-year bonds over 1 year T-bills has also widened.
Some relief
The recent rise in international oil prices may reduce upward pressure on the rupee, which may give RBI elbowroom to reduce dollar purchases and step up bond buys to ensure adequate liquidity in the local market, and help the government borrowing programme.
While the market remains unconvinced over RBI’s ability to manage the government’s borrowing programme, in February, RBI governor Shaktikanta Das had exuded confidence that it will able to manage the high quantum of government borrowings at Rs 12 lakh crore for the next fiscal in a “nondisruptive” manner.
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