Yield to the market

The Reserve Bank of India’s ongoing battle with the bond markets to anchor the 10-year sovereign bond yield close to 6 per cent has attracted criticism. The central bank has tried to explain its position through an article published in its June bulletin. That the bond yield is extremely important to the central bank was made explicit by the Governor when he stated that the orderly evolution of the yield curve is a public good, and that both market participants and the RBI have a shared responsibility in this regard. The article reiterates this view and finds that the yield curve is shifting downward since the second quarter of 2019, caused by extremely accommodative monetary policy. It holds that there is scope for further moderation of long-term yields from current levels. Orderly evolution of the yield curve, is without doubt, important for supporting growth and anchoring expectations regarding inflation and other uncertainties. But the bigger and more immediate concern of the central bank appears to be to manage the large government borrowing this calendar, the cost of which is linked to the yield curve. The central bank has been successful in keeping the overall borrowing cost in the economy under control. Yields on corporate bonds have been moderating over the last few months, leading to an increase in fund-raising through this channel. While this is welcome, it’s obvious that sovereign yields cannot be kept artificially low for long. Yield curve management is beginning to impact price discovery and trading in the G-Sec market.

With a large chunk of the Centre’s borrowing in the 10-year security, the central bank has been sending strong signals to market participants in the bond auctions that it is not ready to accept yields beyond 6 per cent for the 10-year paper. Repeated devolvement of the auctions on primary dealers or no sale taking place in some instances shows that the central bank is fighting an impossible battle. The central bank needs to acknowledge that the impact of the second wave of Covid on growth and the additional government spending resulting in larger-than-budgeted borrowing is applying upward pressure on yields. Add to this, the sharp spike in the WPI and CPI inflation. The RBI is hampering price discovery by trying to keep the lid on yields despite these factors. While 10-year sovereign yields have gone up in most advanced and emerging economies since March, they have stayed flat in India.

Besides this, the central bank is reported to be holding over 70 per cent of the active 10-year government security, with a coupon of 5.85 per cent. While this could be due to the impending rollout of the new 10-year benchmark, the trading volume in the 10-year security had dropped sharply. The RBI should consider letting the yield move a little higher, in order to prevent further market distortions.

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