RBI to buy government bonds worth Rs 20,000 crore via OMO on Wednesday to cap yields

NEW DELHI: The Reserve Bank of India (RBI) will buy up to Rs 20,000 crore worth of government bonds via open market operations (OMO) on Wednesday, the central bank said in a release. Later, in a separate notification, the RBI also announced that it will conduct a special auction on February 11 to sell the same bonds it refused to sell last Friday due to higher yields demanded by the market.

On offer are the 10-year and 5- year bonds for Rs.11,000 crore each. The move is aimed at keeping bond yields under check so that the borrowing plan of the government goes through in a non-disruptive manner and to widen liquidity in the banking system.

“The Reserve Bank stands committed to ensure availability of ample liquidity in the system in order to foster congenial financial conditions. On a review of current liquidity and financial conditions, the RBI has decided to conduct purchase of government securities under OMO for an aggregate amount of Rs. 20,000 crore on February 10, 2021," said the notification. 

After the announcement, 10-year bond yield eased to 6.034 per cent as compared to previous close of 6.071 per cent. 

For Thursday's auction, the government will have the option to retail additional subscriptions up to Rs. 2,000 crore against each of the bonds, RBI said. On Friday, the central bank will be again auctioning Rs.26,000 crore of bonds as per initial plan.

Analysts say this year will be different from the pandemic-hit 2020 and maintaining high levels of liquidity may no longer be easily possible because of reasons more than one, despite the pledge from RBI Governor Shaktikanta Das - tasked with managing a whopping Rs. 12 lakh crore of government borrowing next fiscal - to pursue “orderly completion of the borrowing programme”.

“Economic recovery is gaining momentum. That implies a pick-up in credit growth. Banks will now have more options than the government to lend to, which could put some pressure on G-sec yields (inversely related to bond prices and demand),” said analysts at Crisil Research. Secondly, the RBI will have to keep an eye peeled for inflation amid an expansionary fiscal and rising input costs.

That apart, analysts say, the RBI is also concerned about easy liquidity fuelling asset-price inflation and destabilising markets. 

After the banking system liquidity surplus widened to its highest level of Rs.6.7 lakh crore in recent years on February 2, it has moderated to some extent on the last day of the week to Rs.6.2 lakh crore. The sustained period of liquidity surplus has been on account of increased US dollar purchases by the RBI along with the various liquidity infusion measures being undertaken by the central bank viz.OMO purchase. So far, the RBI has undertaken OMO purchases of G-Secs to the tune of Rs.3.87 lakh crore and OMO purchases of State Development Loans (SDLs) amounting to Rs.30,000 crore.

However, an increase in spending leading to dis-savings by households could moderate bank deposit inflows. Then, outflows towards statutory payments and government market borrowings (States: Rs. 16,950 crore and Centre: Rs. 26,000 crore) could also lead to moderation of liquidity surplus. 

Meanwhile, the RBI, on its part, has begun “normalising” liquidity operation. It had announced a two-step reversal of the 100 basis points (bps) cut in cash reserve ratio (CRR) undertaken in March 2020. This was effectively a reminder that the RBI can buy bonds worth at least Rs.1.37 lakh crore, the amount that will get impounded by restoration of CRR, over the next six months. The banking regulator also invited small investors to directly enter the government bonds market but to what extent this move is going spur demand remains to be seen unless their participation is incentivised.

Analysts also say that it will be difficult for the RBI to anchor yields around 6 per cent as it had fiercely protected earlier. “In all, supply pressures will have a bearing on the 10-year G-sec yield once the RBI starts unwinding its ultra-accommodative monetary policy stance. We expect the yield to settle at 6.2 per cent by March 2021 and rise to 6.5 per cent by March 2022, which would still lower than the decadal average of 7.7 per cent,” the Crisil analysts wrote in a note. 

However, a section of optimists say that bond yields are likely to remain low with RBI intending to be an active buyer in order to control yields and bring down interest rates as promised during the policy meet on Feb 5.

At this point, the spirit seems willing but the flesh is weak given the lack of decisive action from the central bank. "RBI's monetary policy committee did not provide any direct measure but just assurances of ample liquidity spooked the market. Further, the government's borrowing plan added to nervousness pushing up yield prices that forced the central bank on Friday to devolve an entire auction. The RBI has to provide clarity on how it plans to carry out the borrowing plan. Only the RBI can help the yields settle down with timely action," said a bond market participant.

While such tiffs between RBI and traders are not unusual, the bond market is now watching the quantum of purchases and the level of yields at which the RBI chooses to jump in. More OMOs will be required to hold back borrowing costs from continuing its northward journey. With no specific OMO calender in sight, traders peg at least Rs.2.5-3 lakh crore-worth of bond purchases by the RBI in fiscal 2022.

"We believe the tug of war between the RBI’s motivation to support the bond market (via OMOs) and fundamentals that call for gradual liquidity normalisation, is set to intensify,” Nomura analysts wrote in a note.