Mumbai: A pricing contest is playing out between the Reserve Bank of India (RBI) and sovereign bond traders as the central bank tries to deftly manage the government’s borrowing cost, provide sufficient liquidity to the markets, and ensure that its stance of withdrawing accommodation is not diluted.
At a buyback auction of government bonds last week, the RBI accepted bids worth only ₹10,512.99 crore versus ₹40,000 crore worth of securities the government had offered to repurchase, with the central bank rejecting most bids.
In a bond buyback, the government chooses to repay a portion of its outstanding debt before the actual dates of maturity of the securities.
Given that banks are among the largest holders of government bonds, such buybacks release funds into the banking system, which is currently experiencing deficit liquidity conditions.
However, for the RBI, which is the government’s debt manager, the fly in the ointment has been the high prices – or low yields – the market has demanded to sell the bonds back to North Block.
“The question is where the yield on the six-month security should be and where the yield on the one-year security should be. Whether the six-month should be at 6.75% or 7.0%, that is a matter of debate,” said Rajeev Pawar, head of treasury at Ujjivan Small Finance Bank.
The government had offered to buy back three series of securities – two maturing in November and one in January 2025.
“I think the market would have tried and pushed them (RBI) toward 6.75%, which is why the bids failed the last time around. Maybe, yields could adjust a little lower in the next buyback,” Pawar said.
The RBI has announced another bond buyback – this time for up to ₹60,000 crore – to be held on May 16.
The Inflation Conundrum
As the Centre’s debt manager, the RBI aims to ensure the lowest possible cost of borrowing for the sovereign. On the other hand, as the monetary authority, the central bank may not want yields on short-term securities to fall too much when it is still withdrawing accommodation to battle inflation.
“If I assume that quotes have been made substantially lower than where the T-bills are trading, why would they (the RBI) accept it? I don’t see the RBI buying much at yields below wherever the market is – I don’t think there is other signalling apart from smart cash management,” said Rajeev Radhakrishnan, chief investment officer-fixed income, at SBI Mutual Fund.
The reason behind the government’s decision to announce a buyback after six years is straightforward: Amid constraints on spending while the elections are on, the Centre has chosen to deploy its cash to prematurely redeem some bonds and streamline its repayment obligations, analysts said.
This use of the government’s cash also ties in with giving banks relief from tight liquidity conditions and preventing a jump in borrowing costs in the economy.
Liquidity has been in deficit mode for the last few weeks, due to the reduction in government expenditure and the central bank’s dollar sales to shield the rupee from excessive volatility amid global market turbulence.
