RBI STEPS IN WITH MEASURES TO COOL DOWN RISING YIELDS
Says inflation woes and the fiscal situation amid global developments have firmed up yields abroad
The Reserve Bank of India (RBI) on Monday stepped in with a number of measures that would boost demand for government bonds, keep yields under check and improve liquidity in the system.
The RBI said market sentiment has been impacted “by concerns relating to the inflation outlook and the fiscal situation amidst global developments that have firmed up yields abroad”.
The central bank also indicated that it is comfortable with an appreciating rupee, which helps bring down import-led inflation, and said it remained “committed to ensuring comfortable liquidity and financing conditions in the economy”.
Stepping in to boost demand for government bonds, the central bank increased the held-tomaturity (HTM) limit of banks substantially. In the HTM category, banks do not have to mark their investments with the current market rates, which helps the lenders avoid incurring any nominal losses.
Currently, banks are supposed to maintain a quarter of their overall bond holdings in the HTM category. They are required to maintain a minimum of 18 per cent of their deposit base in government bonds, also called statutory liquidity ratio (SLR). Even as the HTM is pegged at 25 per cent of this 18 per cent SLR, the RBI allows the HTM investment to rise, provided it remains within an overall limit of 19.5 per cent of the deposit base. This 19.5 per cent limit has now been increased to 22 per cent.
According to RBI calculations, government securities held in the HTM category by major banks amount to around 17.3 per cent of their deposit base, while in some cases it had reached the limit of 19.5 per cent. This extra limit of 2.5 per cent would mean an extra demand of nearly ~3.56 trillion, bond dealers say. The fresh acquisitions have to be done with effect from September 1 up to March 31. The relaxations would be reviewed thereafter.
This would help create extra demand for the government’s ~12-trillion borrowing programme. The central bank has finished borrowing more than 90 per cent of the first half ’s ~7trillion borrowing. It has to also manage a huge borrowing by the states, and possibly extra borrowing by the Centre towards the end of the year.
“The RBI measures are directly aimed at maintaining orderly market conditions and ensuring financial conditions are congenial at all times. The RBI has been saying that the borrowing programme will be non-disruptive, which appears to have been achieved by an these announcements,” said R K Gurumurthy, head of treasury, Lakshmi Vilas Bank, adding the bond yields may
remain “reasonably aligned to macro factors”.
The central bank refused to sell nearly ~18,000 crore of the benchmark 10-year bond on Friday’s auction as investors demanded higher yields. The 10-year bond yield, which has a coupon of 5.77 per cent, had spiked as much as about 6.2 per cent recently. But the RBI’S past actions forced the yield to soften and it closed at 6.12 per cent on Monday. “The spike in yield has bought to the fore dual role of the RBI as the monetary policy authority and debt manager for governments. The impact on the yield after policy announcement has now been addressed by
higher HTM limits,” said Soumyajit Niyogi, associate director at India Ratings and Research.
Among other measures, the central bank said it would conduct another round of special open market operations (OMOS), under which it would simultaneously buy and sell bonds worth ~20,000 crore in two tranches. In market parlance, this kind of OMO is called Operation Twist.
The central bank has already done one such OMO of ~10,000 crore and another OMO is due on September 3. According to RBI’S notification, there will be two more such operation twists on
September 10 and September 17 of ~10,000 crore each.
The central bank said it will also conduct term repo operations for an aggregate amount of ~1 trillion at the prevailing repo rate in the middle of September “to assuage pressures on the market on account of advance tax outflows”.
The central bank gave options to banks to reverse the funds taken under long-term repo operations (LTROS), to ease their cost of funds.
“Thus, the banks may reduce their interest liability by returning funds taken at the repo rate prevailing at that time (5.15 per cent) and availing funds at the current repo rate of 4 per cent,” the RBI said.
Niyogi said the HTM will check spike in bond yields, and more operation twists will flatten the curve. “Additionally, reversal of LTRO will reduce intertemporal consequences for banks, and will improve appetite for banks to borrow and park in bonds.” The RBI’S take on rupee also piqued the interests of traders.
“There are indications that food and fuel prices are stabilising and cost push factors are moderating. In addition, the recent appreciation of the rupee is working towards containing imported inflationary pressures,” the RBI said. The central bank has of late withdrawn from intervening in the spot currency markets, and let the rupee appreciate to a six-month high, while keeping its forward markets intervention intact. An appreciating rupee theoretically makes import cheaper, and therefore controls inflation. It is considered an indirect method of raising interest rates without touching policy rates, which remain in “accommodative” mode.