Bond vigil

With the Centre seeking Parliamentary approval for spending an additional ₹1.67 lakh crore this fiscal, the RBI cannot afford to let down its vigil on bond prices. Market rates have to be maintained at a low level and investors reasonably assured about capital protection in order to stimulate demand for these securities. The slew of actions taken by the central bank towards the end of last month to cool 10-year yields that had spiked past 6.1 per cent, are to be welcomed. But the battle is far from over. A large government borrowing programme slated for the second half of this fiscal, lack of demand for government paper and an expanding fiscal deficit are factors that will maintain the downward pressure on G-Sec prices. The central bank needs to stay alert to deploy the other tools in its arsenal.

The bond market witnessed a sudden bout of volatility in August when 10-year bond yield that had been moving downward since the beginning of this year suddenly surged past 6.1 per cent. This was due to two reasons. One, spike in inflation for July to 6.9 per cent and two, additional borrowing planned on account of the GST compensation shortfall of about ₹2.35 lakh crore. The measures taken by the central bank have, however, been successful in cooling yields, helping them stabilise at around 6 per cent levels. These include allowing the rupee to strengthen and assuring the market that food and fuel prices are stabilising. The RBI has also announced two more editions of ‘operation twist’ of ₹10,000 crore each, which involve simultaneous buying and selling of government securities to bring down long-term borrowing cost. The central bank proposes to conduct additional term repo operations for ₹1,00,000 crore at a floating rate that will allow banks to reduce the cost of their earlier long-term repos. The most important measure of the RBI was allowing banks to hold fresh purchases of bonds that are part of the Statutory Liquidity Ratio requirement, bought from September 2020 to March 2021, under HTM (held to maturity) category, up to a certain limit. Banks were wary of purchasing G-Secs due to the requirement of recognising the losses in their financial statements. This leeway is expected to allow banks to invest an additional ₹3.6 lakh crore in government securities.

While the RBI measures have provided some respite to bond yields, they have not declined much. This indicates that the market is apprehensive about the combined fiscal deficit (States and centre) that is expected to be at least 11 per cent of GDP in FY21. With nearly half of the humongous ₹20 lakh crore borrowing slated for the second half of the fiscal, bond prices are unlikely to rally. The central bank also has to temper its focus on inflation targeting, especially when inflation is caused by supply side factors.

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