Thursday’s bond auction bombed again, almost 70 percent of it. Indeed, of the four government of India bond auctions conducted since the budget, two have bombed majorly, one partially, and one has succeeded only because the RBI appears to have had a back-to-back arrangement to buy the bonds back from banks.

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A massive government bond issuance of 12 lakh crore rupees for next year, on top of the 12.8 lakh crore of issuance this year, was always difficult for the banks and the debt market to digest. In normal years, like in FY20, debt issuance by the govt was 7 lakh crores.

To the credit of RBI, it managed a better part of Rs 12 lakh crore borrowing this year with aplomb. But once the government announced that it was going to borrow an extra 80,000 crores this and a much higher-than-expected 12 lakh crores next year, the debt market lost all appetite, even for the tail end of this year’s bond issuances.

The RBI governor went all out to assure the central bank’s support, in his statement on Feb 5, he said not just the monetary stance, the RBIs liquidity stance will remain accommodative well into FY22.

Alas, the assurances haven’t been enough. The markets want RBI to walk the talk every week. They apparently want RBI to do a 20,000 crore OMO (open market purchase of bonds) every week. RBI didn’t announce an OMO on Feb 5, along with its monetary policy, and that day’s auction devolved almost entirely.

The following Monday it announced a 20,000 crore OMO. Yet, RBI could sell at the auction on Thursday only with an assurance to buyback. The Friday auction, which apparently didn’t have such an arrangement, failed partially.

This week the RBI again disappointed the market by not announcing an OMO, but a twist – a simultaneous purchase of long bonds and a sale of short-term bonds. The debt market replied by not showing up at the following auction on Thursday, Feb 18.

Why is the RBI allowing auction after auction to devolve? Because it doesn’t want to be seen accepting higher yields. Indeed, it has repeatedly used on-screen purchases to keep the benchmark 10-year bond at 6 percent. But its refusal to accept bonds at higher yields in the auction isn’t helping. Because primary dealers who have picked up the unsold stuff, deduct their underwriting earnings and dump the bonds at lower prices in the market thus driving up the yields anyway.

So, what can RBI do? As said before, maybe just walk the talk consistently, like the Fed and the BoJ do. Come every Thursday or Friday, predictably, consistently, and reliably and do an OMO. In course of time, the markets may adjust to lower yield levels.

As dealers point out, in any case, the RBI has bought off bonds from banks in back-to-back arrangements. Why not do it cleanly through predictable OMOs? Or at least buy off devolved amounts from primary dealers at slightly higher fixed rates.

After being ahead of the curve all of calendar 2020 and leading from the front, why be parsimonious with support now at the tail end of the borrowing, especially when the debt market has been psyched out by a truly humongous government borrowing program.

Bond dealers also point out that any economist worth his salt believes RBI has to normalize the ultra-loose liquidity policy. If the economy is rapidly recovering and will post at least 11 percent real GDP growth in FY22 and inflation by RBIs own forecast will average 5 percent in FY22, it stands to reason that an overnight rate of 3.35 percent can’t hold for long.

The RBI's one attempt to pull up the ultra-short-term rates to the reverse repo level of 3.35 percent was seen as the first step of normalization of liquidity. This sub-conscious expectation of normalcy, plus the rise in global yields and in commodity prices are all consistently pushing up yields. The macros that supported big rate cuts and massive liquidity in 2020 are seen to be dramatically different in 2021, and hence the markets‘ expectation of higher yields.

Hopes of retail bond-buying or India’s entry into the bond index are quite a distance away. Indeed, lately, foreign funds have been selling Indian government bonds.

The RBI officials, according to sources, are angry and upset at the bond markets sulking. Maybe it's time for the central bankers to treat the bonds markets more like a patient parent handling a confused and scared teenager. A little more hand-holding, a little more pocket money for PDs, a willingness to pick up the slack, may do the trick.

Yes, massive liquidity through bond and dollar buying is a problem. But in the fullness of time, a standing deposit facility or CRR hikes (remunerated if over 4 percent) can be resorted to. But before all that the need of the hour is to ensure there is a market that is able to discover price.

(Edited by : Yashi)

First Published:Feb 19, 2021 8:27 AM IST