The chatter of the bond market is being heard beyond the dealing rooms of Nariman Point and Bandra. Bankers and fund managers, baffled by RBI’s actions over the past six months, are now guessing how far to trust the government. How believable would be the Budget numbers? Is RBI ready to cough up extra dividend?
For months, no one could decipher RBI’s moves as it relentlessly sold securities to mop up extra liquidity created by dollar inflows. The central bank seemed to be on autopilot: it appeared to be selling securities, almost mechanically, amid a growing murmur that it was overdoing it. Then one day, it abruptly stopped selling — probably out of panic when the benchmark bond yield rose above 7 per cent.
Everyone in the market hoped for the central bank to communicate and guide. It didn’t. And, then this week, when one of its senior-most officials finally broke the silence — by admonishing banks for not being smart enough in managing their bond books and mistakenly expecting RBI to bail them out — everyone wished he had kept quiet. As bond prices and bank stocks once again dipped, shaken stateowned lenders called New Delhi. Within hours, the finance ministry tossed out a breaking news (of a lower borrowing number) to partly offset the damage caused by RBI.
The open market operations (or OMO) — the buying or selling of securities by central banks to expand or contract liquidity — have given way to another kind of OMO: open mouth operations by the central bank as well as the government.
The bitter comment of the RBI official, even if irrefutable, was illtimed: bond yields have hardened, banks have been badly hit by bond losses in the December quarter, oil prices are up (though inflation is believed to be stabilising), and the central bank has once again gone wrong in the tricky job of forecasting liquidity.
Perhaps, it’s a price to pay for letting hard core academicians play a serious role at the central bank. Shooting bond yields may push up the blood pressure of bankers already burdened with the task of salvaging bad loans and finding turnaround artists for bankrupt companies. However, to the professor-turned-RBI deputy governor, bond prices and bank stocks are far ephemeral compared to the important and enduring message on balance-sheet discipline that he wanted to drive home — even if it meant raising the subject publicly. Unlike a bureaucrat or a traditional central banker, he may lack the tact of castigating them behind closed doors.
But the behaviour of the central bank can hurt its future credibility in the same way as a question mark on the fiscal deficit figure can raise doubt over government’s claims. Technically, the difference between the policy rate (at which RBI borrows from banks in the short term) and the 10-year bond yield is wide enough to suggest interest rate hikes by the central bank, but almost no one in the market expects RBI to announce rate hikes immediately. That’s because the market knows that factors beyond macro realities have driven up bond yields.
The fiasco in the bond market has unfolded at a time when there is a mismatch of supply and demand of bonds. Even as the government continues to borrow, there are not too many big buyers: foreign funds have almost reached their combined investment limit, RBI is not buying and incremental purchase of gilts by banks is down. If growth returns and loan offtake picks up, bond yields would further soften as banks holding of excess government bonds would come down. A clearer picture would emerge in the weeks following the Budget.
Taking bond yields to realistic levels would require correcting the demand-supply imbalance: Creating new demand by letting offshore funds buy more government bonds, and controlling new supply of bonds by preserving fiscal discipline and keeping next year’s borrowings at closer to this year’s level. It may be easier said than done as the government prepares for 2019.
Source:ET
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