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Is the RBI failing in its mission to manage the 10-year G-sec yield?

DINESH UNNIKRISHNAN

 

APR 16, 2021 / 02:27 PM IST

 
 
 
 
 

The RBI wants to artificially suppress yields in the face of opposing pressures such as wholesale inflation rising to an eight-year high and the uptick in interest rates globally. Its plan hasn’t worked so far, and some economists say the monetary authority may have to eventually bow to the market forces.

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Is the Reserve Bank of India (RBI) losing its battle on yield management?  The yield on the 10-year Government security rose to 6.159 per cent on Friday compared with Thursday’s close of 6.13 per cent.

The yield had spiked sharply on Thursday from the previous day’s close of 6.01 per cent after the first auction of RBI’s Rs 1 lakh crore G-SAP 1.0 (Government securities acquisition plan), announced in the last policy. Nothing went as planned for the central bank in the bond market.

On Thursday, the RBI concluded the first phase of G-SAP auction purchasing Rs 25,000 crore across five different maturity papers. That was part of a massive plan to keep the bond market happy with promise of liquidity availability and central bank's readiness to act on a continuous basis. After the auction, the 10-year G-sec yield immediately shot up to 6.12 per cent against the previous close of 6.01 per cent.

What could have triggered the spike in bond yields? In fact, there are multiple factors at play:

One, market was hoping for a better response from the RBI. “Market is not convinced,” said Madan Sabnavis, chief economist at CARE Rating agency, referring to the central bank’s lack of aggressiveness at the Thursday auction. The Government has a massive borrowing programme of Rs 12.05 lakh crore scheduled for FY22. The RBI’s endeavour is to keep the yield down to lower the borrowing cost of the Government.  Traders said the expectation was that RBI will be more aggressive in buying the 10-year paper. There was disappointment in the market.

Secondly, the high WPI inflation data (wholesale price inflation) that was published on Thursday spooked markets. The sudden rise in cost of fuel, including petrol, LPG and diesel percolated down into the economy in March as wholesale inflation in the country reached a high of 7.3 percent. Measured by the Wholesale Price Index), wholesale inflation had been 4.17 per cent in the previous month of February. While it has been on a continuous uptick from December onwards when it was just 1.9 percent, the latest rise shows broad based price rise shot up in March.

A high inflation typically warrants tightening of interest rates. But, the RBI which is on a growth-supportive mode is maintaining an accommodative stance. Markets didn't agree with the RBI's stance.

Third, globally interest rates are inching up. The US treasury yields are hardening. India's bond market cannot stay in isolation, ignoring the global cues. On Wednesday, the U.S. Treasury yields ended higher as Fed Chairman Jerome Powell outlined more details on the timetable for interest rate hikes, suggesting it would be a while before the central bank pulled away from its accommodative policies.  The widely tracked 10-year Treasury yield  rose 1.5 basis points to 1.637 per cent. Since last year, the Fed has been buying $80 billion in treasurys and $40 billion in mortgage-backed securities every month.

RBI's failing battle

That brings us to the key question. Is RBI's failing in its endeavour to keep the 10-year yield low? So far, the RBI has been determined to keep the yield low to reduce the borrowing cost for the government. In addition to the G-SAP plan, the RBI said it will also continue to deploy regular operations under the LAF, longer-term repo/reverse repo auctions, forex operations and open market operations including special OMOs to ensure liquidity conditions evolve in consonance with the stance of monetary policy, the RBI Governor said during the last policy presser.

For the Government, the RBI's promise is good news that reduces borrowing costs. But, a section of economists aren’t comfortable with RBI artificially keeping the interest rates lower in the financial system as it will lead to distortions. In healthy economic system, the interest rates pricing should be driven by demand-supply, and shouldn’t be artificially suppressed by the central bank. It will have other consequences.

"The RBI cannot keep pushing the yields down when every other factor is driving the market in the opposite direction," said a trader with a private bank in Mumbai.  "The interest rate pricing should be driven by the market, not by artificial yield management," said the trader.

The 10-year G-sec yield is up by 30 bps this year. Bond markets may not follow the RBI's cues given the stronger clues from elsewhere, especially hardening interest rate globally and mounting upside risks on inflation in the domestic market. At some point, the central bank will have to reconcile with the market.

 

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