India's bonds reflect nothing but the RBI’s desires

Under the G-SAP, two-fifth of the total Rs1 trillion bought by the RBI has been of the 10-year bond. (Photo: Mint)

2 min read . 07 Jul 2021Aparna Iyer

In normal times, bond yields act as a gauge of the balance between growth and inflation by showing where interest rates should be. This gauge for India is broken and bond yields, especially the benchmark 10-year, reflect nothing beyond the desires of the central bank.

The benchmark 10-year bond has been stuck at around 6% for more than a year now despite the pandemic triggering a recession and then a subsequent recovery of the economy. The impact of the recent surge in inflation and the government’s mammoth borrowing have all whittled away under the relentless grip of the Reserve Bank of India’s (RBI) incessant bond purchases.

Where it could not take the supply off a fatigued market, the central bank has resorted to talking down the yields. It has even changed the way auctions are conducted last week. Auctions for the tenures of two, three, five, ten and 14-year will now be based on uniform pricing instead of multiple pricing method. Meanwhile, bond purchases will continue.

The RBI announced on Monday that it will buy Rs20,000 crore worth of bonds under its G-SAP 2.0 (government securities acquisition programme). To be fair, the central bank’s balance sheet support was crucial in FY21 given the size of the government’s borrowing and the relative fatigue in the bond market. In the absence of the roughly Rs3.2 trillion bond purchases by the central bank, yields could have surged and in turn made borrowing expensive for private companies.

But we cannot ignore the flipside of a deep central bank intervention. A distorted yield curve is only one of them. Trading volumes have dropped, making the market thin and susceptible to more volatility. In fact, the 10-year benchmark bond has only a fraction of its stock available for trading as a large part of the outstanding now sits on the RBI’s balance sheet. Ergo, the yield is hardly reflective of economic realities. The focus of the RBI has been the 10-year benchmark yield. Under the G-SAP, two-fifth of the total Rs1 trillion bought by the RBI has been of the 10-year bond.

"It is futile to look at the 10-year as the yield doesn’t reflect anything. But we can see the movement in the 5-year and 15-year bonds and there they clearly show that inflationary concerns have taken hold," said a bond trader requesting anonymity. The 5-year bond yield has risen by 20 basis points in the past one month after retail inflation for May surged beyond 6%.

Analysts believe that yields will now inch up steadily to reflect the expected unwinding of the RBI’s policy accommodation. Even so, it would be a long time before the ten-year yield becomes more relevant. Perhaps a new ten-year bond issue later this week is the first step.