Yields on the 10-year government securities rose sharply to 6.153 percent immediately after the monetary policy announcement from yesterday’s close of 6.07 percent, as the Reserve Bank of India fell short of meeting bond markets’ expectations.
The 10-year benchmark yield was later trading at 6.106 percent. While the Reserve Bank of India comforted markets with a promise to maintain an “accommodative” liquidity stance through the current fiscal and into the next, it stopped short of announcing any Open Market Operation (OMO), as widely anticipated by the bond dealers.
Purchase of bonds from the open market by the RBI helps bring down yields, and a schedule gives bond traders comfort to buy long-dated bonds.
With economic growth expected to return to normal in FY22, more companies and individuals are expected to borrow, causing interest rates to rise.
“The stance of liquidity management continues to be accommodative and completely in consonance with the stance of monetary policy. The RBI stands committed to ensure the availability of ample liquidity in the system and thereby foster congenial financial conditions for the recovery to gain traction,” RBI Governor Shaktikanta Das said on Friday.
“I think probably some sections of the markets expected that there could be a surprise rate cut- partly that. Partly, the fact that we are still continuing with the rollback of CRR (Cash Reserve Ratio) and the MSF (Marginal Standing Facility) relaxation that was given,” said Neeraj Gambhir, President, Head Treasury & Markets at Axis Bank.
“We are in a gradual unwind of COVID-19 related measures, and even though RBI Governor has been eloquent about the support to the government borrowing programme, and the fact that liquidity in the system will continue to remain as accommodative, and consistent with the monetary policy stance, I think the market is nervous about how this large government borrowing programme is going to get absorbed, and what is the kind of support that will be required from RBI going forward. All right things said, I think the markets are still somewhat nervous and that’s getting reflected in the prices,” he explained.
RBI did announce other measures to allay any worries on the liquidity front. It extended the easing available under the held-to-maturity (HTM) norms by another year until March 2023. It also allowed retail investors direct access to the government bond market.
RBI also pushed back the reversal of the cut in CRR that was due in March until May 22, 2021. Governor Shaktikanta Das added that the CRR normalisation would, in fact, open up space “for a variety of market operations to inject additional liquidity.”
What also contributed to the rise in bond yields is RBI increasing the inflation forecast for the first half of the fiscal year 2021-22 from 4.6-5.2 percent to 5-5.2 percent. Even though RBI remains in an “accommodative” stance, which means it will not hike rates, a higher inflation forecast effectively rules out the possibility of further rate cuts anytime soon. Rates could stay at current levels, or even climb later in the future as growth normalises. This makes existing bonds unattractive.
Typically, when interest rates go up, new bonds issued come with a higher interest rate and provide more income to investors. Inversely, when rates go down, new bonds issued have a lower interest rate and do not seem as attractive as older bonds. This may tempt foreign investors to book profits and go to other markets, where they may get higher yields.
Some experts opined that a six percent plus yield could be the new normal, and fundamental changes in the macro-economic environment warrant a repricing of the yield curve.
“Markets find themselves in a new environment of better growth prospects, increasing inflation risks (more demand-side pressures), lower liquidity surplus and a significantly expansionary fiscal policy. These fundamental changes warrant a repricing of the yield curve towards a more “fair and consistent” band with the underlying economic metrics. We think this is likely to lead to the 10-year yield trading between 6.10-6.20 percent in H1 FY22,” said Abheek Barua, Chief Economist, HDFC Bank.
First Published: Feb 5, 2021 2:39 PM IST
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