The ongoing surge in the bond yields will push back lending rate cuts and delay the fragile economic recovery, and there is a need for the Reserve Bank to cool them down, says a foreign brokerage.

“We think the challenge for the Central Bank is to comfort the markets with a mix of confidence-building measures, as the rising yields push back lending rate cuts and delay the recovery,” American brokerage Bank of America Merill Lynch said in a note on Friday.

The “easiest way” to cool the government securities markets will be to cancel the extra government borrowing of ₹50,000 crore announced last month and fund the possible fiscal slippages by drawing down the government surplus cash balances with the RBI, it said.

The bond yields surges on average by 47 bps in the December quarter and had touched 7.44 per cent in the last week of December, putting banks in a quandary, as their mark-to-market losses for the quarter is pegged at ₹15,000 crore.

The brokerage said over the past three years, government has been running surplus cash balances with the RBI averaging ₹1.50 trillion on last March 31, which are accumulated through higher-than-budgeted small saving collections, surplus of State governments parked in intermediate T-Bills and non-competitive bids and advance tax payments in the March quarter.

The brokerage also advised the Finance Ministry against drawing from RBI’s contingency reserves created from past profits and from the central bank’s currency and gold revaluation accounts,which is a buffer against adverse foreign currecny movements.

Bond buybacks by government, where it has done ₹30,000 crore as against a budgeted ₹75,000 crore, can also calm the G-sec market, it said.

Open market operation by the RBI of over ₹50,000 crore “would be the strongest signal as that would not only supply durable liquidity but also re-assure market concerns on the yield curve”, the report said.

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