The bond market seems to have reconciled with the fact that no matter what the inflation print, the Reserve Bank of India (RBI) will keep the 10-year bond yields below 6 per cent, say experts.
To that effect, the central bank seems to have trained its focus on the 10-year bond, mopping up most of it to create a liquidity shortage in the market of that particular paper. Such constricted liquidity helps drive yields even with relatively lower value of transactions.
In declared secondary market operations, through government securities acquisition programme (G-SAP) or open market operations (OMOs), the RBI has purchased Rs 41,451 crore of the 10-year paper, out of the outstanding stock of Rs 91,270 crore. The central bank also does anonymous purchases from the market. Bond dealers say the RBI, through a clutch of nationalised banks, could be regularly picking up the 10-year bond.
The RBI has made no secret of its preference for targeting the 10-year bond. It is the benchmark for many products, is the most traded paper in the market, and even the corporate sector raises bonds making the 10-year government securities as the benchmark.
The RBI, in the past, has made clear its preference for keeping yields soft. It also sees the 10-year bond as an important benchmark, and that can explain the penchant for controlling the yields by controlling the supply of the paper, say bond dealers.
“The RBI has probably focused on the 10-year because the maximum volume and liquidity is in this paper. The rest of the curve is expected to align with the 10-year movement. However, going ahead, once around 40-50 per cent of the adult population gets vaccinated and green shoots are visible on the growth front, the RBI is expected to focus on inflation and accordingly policy response will be visible,” said Marzban Irani, chief investment officer, fixed income at LIC Mutual Fund.
The central bank does pick up other bonds too, but the focus on 10-year has brought in certain complacency in the minds of the market participants.
The Wholesale Price Index rose to 10.49 per cent in April 2021, which is more than a decade high, but largely owing to a base effect, while the Consumer Price Index (CPI)-based retail inflation was at 4.29 per cent in the same month.
“Even if the RBI has been targeting the 10-year, the market as a whole is factoring that in their expectations and pricing the rest of the curve accordingly,” said Badrish Kulhalli, fund manager at HDFC Standard Life.
“Papers with a slightly lower maturity are trading at significantly higher yields than the 10-year bond. So, the 10-year bond may be at very rich levels, but that does not cause any significant impact on the rest of the curve. The objective of holding it low is to signal a continued low yield regime. As long as the RBI is willing to use its balance sheet for holding yields low, they will stay low,” Kulhalli said.
The feeling in the market, though, is that no matter what the inflation numbers, the RBI will chip in to bring down the yields.
“There is a complete ignorance and denial of inflation risk premia by the market, there was not even a bout of volatility during the day WPI clocked a decadal high. Given the pandemic condition, rate has to be low and supportive, but complete ignorance of high inflation amid inflation targeting framework is no less worrisome,” said Soumyajit Niyogi, associate director at India Ratings and Research.
The RBI is not alone in targeting the yields though. The Bank of Japan (BoJ) does it already. However, there is a qualitative difference.
“What BoJ, ECB have been doing is explicit target of specific yield and what we are doing is implicit targeting. The difference in approach is basically owing to BoP structure and inflationary conditions. Those nations are mostly suppliers of capital and have long been into the deflationary era, we are just opposite,” Niyogi said. RBI’s purchase of the benchmark 10-year bond (5.85% coupon)*
|G-SAP||May 20, 2021||8,345 crore|
|OMO||May 06, 2021||10,000 crore|
|G-SAP||Apr 15, 2021||7,511 crore|
|OMO||Mar 25, 2021||4,103 crore|
|OMO||Mar 18, 2021||5,024 crore|
|OMO||Mar 10, 2021||6,468 crore|
* Total Outstanding stock: Rs 91,270.508 crore G-SAP = Government Securities Acquisition Programme OMO = Open Market Operations
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