Bond yields rose 20 basis points (bps) on Monday in response to the steep hike in government’s borrowing programme, but banks, sitting with a huge amount of idle cash, chipped in to arrest a free fall in bonds.

As yields rise, prices of bonds fall, and vice versa.

The government had surprised everyone with a revised borrowing programme of Rs 12 trillion, against Rs 7.88 trillion planned. The weekly borrowing will be Rs 30,000 crore, as against Rs 19-20,000 crore earlier.

The sharp increase, with no indication of a private placement with the Reserve Bank of India (RBI), has rattled the bond market. The market now expects the central bank to announce an open market operation (OMO) of at least Rs 2-3 trillion. But the RBI did not announce any such move on Monday as banking system surplus liquidity continued to remain over Rs 8 trillion.

An OMO would mean buying bonds from the secondary markets, which would push up the liquidity even further. However, the market participants are certain that the RBI can come up with Operation Twist kind of measures, in which the central bank sells short-term bonds and buys long-term bonds.

This brings down the yields on the dated bonds, which can be used by the government to borrow cheaply. A relatively softer yield is necessary as even states will need to borrow from the markets due to Covid-19 dislocations. The total borrowing between the Centre and states could reach even Rs 20 trillion in the fiscal, market participants expect.

“Huge liquidity and hope of the RBI OMOs will keep rates in check,” said Devendra Dash, head of asset-liability management at AU SFB.

BofA Securities wrote in a report that the excess borrowing and the resultant fiscal pressure can be managed through RBI OMO and even deficit monetisation. This simply means that the central bank buys the government bonds directly from the government.

The RBI can also incentivise the banks to draw some of their surplus funds into money markets through extending some regulatory leeway, such as allowing the bonds to be included in the held-to-maturity (HTM) category to avoid calculating mark-to-market losses. BofA also suggested a Covid-19 cess.

Everyone is waiting for a stimulus package for the economy, and therefore not taking a firm view on the bonds. But the Friday’s borrowing programme did indicate a rise in the Centre’s fiscal deficit. BofA expects the fiscal deficit at 5.8 per cent of gross domestic product (GDP).

Anubhuti Sahay, chief economist of Standard Chartered said the higher government borrowing implies a FY21 fiscal deficit of 6 per cent of GDP, versus 3.5 per cent budgeted estimate. But the deficit will likely widen further to 7.4 per cent of GDP on revenue shortfall.