RBI's 'Operation Twist' aims at addressing hardening long-tenor bond yields

The special open market operations (OMO) announced by the Reserve Bank of India (RBI) late Thursday is aimed at addressing the hardening in longer-tenor bond yields since the December policy review, according to a DBS report.

The OMO will involve a simultaneous buy and sale of government securities, worth Rs 10,000 crore on December 23 - purchasing 6.45 per cent government bonds maturing in 2029 and simultaneously selling the same amount of short-term bonds maturing in 2020 (Operation Twist).

The report said this move (also known as ‘Op-Twist’) is part of broader measures by the RBI to expedite policy transmission, when seen in the broader context of prodding banks to peg part of the loan book to external benchmarks, keep an accommodative policy bias, provide support to non-bank institutions and keeping liquidity ample.

More steps are likely to smoothen the liquidity and credit premia aspects of the lending rates to hasten the pass-through of an easy monetary policy, it added.

"The move will be liquidity neutral, unlike traditional OMOs. There was no indication whether it was a one-time exercise or part of continuing operations. Given the scope of likely additional borrowings in early 2020, we reckon more are likely to follow to limit rise in the longer-tenor yields," said Radhika Rao, Economist – India, Thailand & Eurozone, and Eugene Leow, Rates Strategist - G3 & Asia, DBS.

The report said the Government Security (GSec) yield curve is expected to embark on modest flattening over the coming quarters as the RBI takes steps to reduce term premium.

The authors of the report observed that over the past few months, long-term bonds failed to rally despite further RBI monetary easing, widening the 10 Year premium vs the repo rate to 140-150 basis points (bps). Most of this is driven by fears of fiscal slippage and more recently, indications that the RBI may be on pause after an aggressive cut cycle, they added. One basis point equals one-hundredth of a percentage point.

"We reckon that the authorities may be more comfortable if the 2Y/10Y spread is capped at 100bps (the recent peak of 115bps was registered in early December)," the authors said.

The report noted that a selloff in the short end of the GSec yield curve appears unlikely at this point. Short-term T-bills, by contrast, have been trading below the repo rate as liquidity remains ample, allowing the policy rate cuts to pass through.

"With growth concerns still lingering, it is extremely unlikely for the RBI to reverse gears just yet. Moreover, food prices are the key driver of headline inflation. Unless this phenomenon spills over to the rest of the CPI basket, we still think that the RBI will keep to a dovish bias, anchoring short-term Rupee rates," the authors said.