MNI MARKET ANALYSIS: RBI/Bond Market Dynamic

The tantrum evident in the Indian bond market post-budget troubled the RBI. In response the central bank announced measures to support the bond market, assuring participants it would ensure liquidity and allowing access to retail investors.

From the perspective of bond market traders this was like bringing a knife to a gun fight; bonds continued their sell-off forcing the RBI to reject all bids at auction the following day, unwilling to lock in higher yields.

RBI succumbs

The RBI then yielded to the tacit demands of the bond market and announced direct support to the bond market through OMOs. The OMO's were well received, having the desired effect both post-announcement and post-operation. Out of the INR 200bn the central bank targeted through four securities, the bank focused 75% in the 10-year segment alone. The bank also bought bonds at lower yields, which helped support demand.

The RBI, in what would be a belt and braces move, are also suspected to have intervened in the secondary market by buying bonds anonymously. A special auction after the OMO drew strong demand and lower cut-off yields. Around INR 250bn of bonds were bought in the secondary market by the "others" category of buyers. Speculation is that surprise demand at the auction was from state-run banks and primary dealers buying the notes to sell on to the central bank.

Where does it end?

The message appears to be that the RBI will not tolerate 10-year yields above 6.00%, irrespective of the amount of issuance. Will the RBI's focus remain on the 10-year sector? Or, once 10-year yields are anchored do the RBI have yield levels in mind for other maturities that could be targeted? The RBI's challenge is to reassure market participants that it will stick to its accommodative stance, even as it starts to unwind its emergency liquidity measures.

There are other pitfalls which could lead the RBI to undertake additional supportive measures, the Indian economy is expected to rebound strongly in 2021/22, this could open up new avenues for lending and leave banks with little incentive to buy additional government securities.

The economy is expected grow 10.5% in 2021/22 after contracting year, while credit growth expected at 8-10% from around 5% in fiscal year 2021.

Indian banks are obligated to hold at least 18% of their deposits in liquid assets including statutory liquidity ratio bonds, making them captive buyers of government securities. However, holdings are already well above these thresholds, 28.6% in December, as the pandemic and subsequent recession limited room for lending. However as economic improvement spurs credit demand banks are likely find more profitable avenues for funds, which would see government securities fall out of favour.

The RBI had also set higher underwriting fees at the most recent auctions, raising concerns over investor takedown.