The monetary policy committee left rates unchanged and continued its stance of maintaining accommodative stance on Friday. The Governor went to great lengths to “not rock the boat”, as he stated, particularly with the shore (end of the pandemic) in sight and given the need to prepare for journey beyond the pandemic. But the bond markets were not too impressed, with the 10-year G-Sec yield hardening 5 basis points to close at 6.318 per cent on Friday.
Tough balancing act
The central bank has a tough balancing act to begin moving towards policy normalisation like other central banks while ensuring that economy and markets are not disrupted.
Surging liquidity surplus means it cannot continue supporting the bond market. Surplus liquidity averaged ₹9.5-lakh crore in October, up from ₹7-lakh crore in the June to August period.
There were two measures announced to manage the surplus and short-term rates. One, further G-SAP auctions have been halted, though the central bank said it would conduct G-SAP auctions and other liquidity management tools such as operation twist and open market operations, should the need arise.
Two, it plans to increase the quantum of the 14-day VRRR auctions to increase it to ₹6-lakh crore by December and conduct 28-day VRRR, if needed. The Governor has assured that even with this, liquidity absorption under fixed rate reverse repo would still be ₹2-lakh crore to 3-lakh crore by December
The cessation of the G-SAP auctions is a negative for bond markets as it reduces the absorption of G-Secs to that extent.
Banking on other tools
While the central bank promises to use other tools to balance the supply, the G-SAP auctions gave visibility to bond markets, which is now withdrawn.
VRRR auctions will not alter the liquidity in the system as the RBI is only trying to move the existing liquidity to these auctions, where it will have greater control over rates; the intention is to move short-term interest rates higher. This is expected to be a precursor to moving reverse repo rate higher in the upcoming policies.
The bond market is worried because supply will remain elevated though demand is being reduced.
With the need to sterilise capital flows, liquidity is expected to remain elevated. Also, the market is not entirely convinced about the lowered inflation projection.
“In the absence of durable absorption, it is unlikely that the short end rates would directionally move closer to the policy rates. Market direction is expected to remain volatile as the overhang of additional measures would remain.
“Even as the near-term domestic CPI prints may provide some relief, external factors such as commodity prices and unwinding of monetary accommodation globally could counter balance that,” says Rajeev Radhakrishnan, CIO - Fixed Income, SBI Mutual Fund. “Liquidity management is also hamstrung by the RBI unwinding of forward premia by as much as $23 billion in the last couple of months.
“If the RBI wants to discourage liquidity injection in lieu of such unwinding, as the MPR notes, the resultant rollover can trigger a vicious cycle of higher inflows and even further increase in the forward premia,” notes Soumya Kanti Ghosh, Group Chief Economic Advisor, SBI.
Global risk aversion
Further, if global risk aversion increases, there could be higher FPI outflows from G-Secs, applying upward pressure on yields. With all these tailwinds, bond yields can inch higher in the coming week.