Forget economy, bond market is happy with liquidity infusion by RBI

The bond yields hardly moved when the government announced its stimulus measures
The bond market seems to be no longer taking cues from the economy but is happy with the daily dose of liquidity infusion by the Reserve Bank of India (RBI).

The bond yields hardly moved when the government announced its stimulus measures last Thursday, and any adverse movement was checked by the central bank’s announcements of open market operations (OMOs) to buy and sell bonds from the market. On the same day, the central bank had conducted another OMO where it simultaneously purchased and sold Rs 10,000 crore of bonds on each side.

Through these OMOs, and occasional outright bond purchase announcements of Rs  20,000 crore each, the RBI is keeping the yields soft and the bond market happy. So much so that, the government’s Rs 2.65-trillion stimulus announcements, of which nearly Rs 1.5 trillion impacts the fiscal directly, did not flutter the bond market. In normal times, the yields would have shot up fearing widening deficit, and the possibility of extra borrowing.

But the Indian bond market is not alone in this easy-going attitude. Globally, central banks are indirectly monetising deficits or infusing liquidity in the market to keep bond yields, and therefore, the interest rates low. Coming out of this easy money policy will be difficult, say experts.

“The growth inflation dynamics have changed drastically in recent months, whereas the bond market is still expecting ultra-loose monetary conditions to continue,” said Soumyajit Niyogi, associate director at India Ratings and Research.

“This conundrum has now become a global phenomenon. That’s the reason the market is absorbing everything with the belief that the central bank would support,” Niyogi said.

Specifically, for India, bond dealers are talking about a tight yield range for the rest of the year.

“The bond market firmly expects the bond yields to remain within 5.80 to 5.95 per cent level. Any deviation beyond 5.95 will be immediately met by the RBI through its OMOs, or even through open mouth operations,” said a senior bond trader with an insurance company.

The so-called open mouth operation is the market slang for RBI communication, which has become a strong policy tool under Governor Shaktikanta Das. Time and again Das has engaged with the market directly, after realising RBI’s signals of cancelling OMOs, or devolving heavy amounts of bonds may not be working out to the extent that the central bank would have desired.

Das in the past has talked about how the RBI measures have brought down yields, and compressed spreads, on government and corporate bonds. In the October monetary policy, the governor dedicated an unprecedented 675 words to directly address the bond market and correct any “disconnect between the rationale underlying the RBI’s debt management and monetary operations on the one hand, and expectations in the market, on the other”.

In as direct as it can get a message to the market, the governor assured the bond market that the RBI “will maintain comfortable liquidity conditions and will conduct market operations in the form of outright and special open market operations”.
The words were followed up with the doubling of OMO auction size to Rs 20,000 crore.

“After the October policy, it would be foolish to take a contrary stance against the RBI. This is as direct a message as it can be. It is both an assurance and a warning,” said another senior bond dealer.

And therefore, the bond market will pretend to look the other way and comply with government’s Rs 12 trillion market borrowing, and possibly more in the coming days knowing well that RBI will use its balance sheet to absord the excess flow and still not call it indirect monetisation, say bond dealers. The RBI’s logic is also convincing here. Since February 2019, the policy rate has been cut by 250 basis points, with 115 basis points cut in repo coming since the lockdown in end-March. But the bond yields have not fallen as much.

For example, on March 26, a day before the RBI’s out-of-turn policy announcement, the 10-year bond yield was 6.22 per cent. It closed at 5.88 per cent on November 13, which is merely 34 basis points of movement. Hence, from the RBI’s perspective, there’s lots of space for the yields to soften. If not, there’s no reason for the yields to rise at least.

But this situation cannot continue for long. Neither the RBI can afford to continue swelling its balance sheet by central and even state bonds, nor the bond market can expect to keep floating on easy money.

“It’s high time for anchoring such expectations. Once fiscal policy has started spreading its wings, monetary policy should move towards safeguarding the economy for sustainable recovery,” said Niyogi.

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