RBI Takes Over the Bond Market, Price Discovery is Hampered

• RBI to conduct on tap TLTRO for a total amount of up to Rs 1 trillion
• RBI to conduct open market operations (OMOs) in SDLs as a special case during H2FY21
• OMO bond purchase auction for Rs 20 billion scheduled for this week
• 5.79% 2030 bond yield closed at 5.90%, down by 10 bps while 5.77% 2030 bond yield closed 5.94%, down by 6 bps
• 5-year OIS yield came down by 6 bps to 4.43%
• Liquidity stood at Rs 2.7 trillion as compared to Rs 2.01 trillion previous week

The aggression of RBI came out came out fully in the October 2020 policy review. Effectively, RBI governor Shaktikantan Das told the bond market that its functions are being taken over by the central bank. The reason for such aggression was that the bond market took up government bond yields and SDL yields by 40bps to 50bps last month on worries over the incessant and increasing supply of bonds. This did not go down too well with the RBI and the government and resulted in aggressive policy steps to rein in the market from performing its normal duties of price discovery.

The steps included government bond purchases and SDL purchases, which is the first ever time on record that RBI will purchase SDLs. Forward guidance of keeping rates at all time lows for extended periods of time and inflation forecast to come down to its target of 4% levels in the first quarter of next year were reinforcements of its commitment to keeping down rates.

Specifically, RBI addressed the fact that bond markets are not listening and increasing the cost of government borrowing. In the last month, three auctions of the 10 year government bond of Rs 180 billion each was devolved on the primary dealers, who underwrite auctions, as they bid at higher yields in the auctions.

Bond markets are now held captive by the RBI, as they cannot express their views on macro economic policies and expectations on inflation. In the short term, bond yields will stay lower, as RBI has taken out the market's ability to short but in the longer term, the repercussions will be catastrophic if the economy does not recover in a sustained manner.

During the week, the 5.77% 2030 yield decreased by 6 bps to 5.94%, the 5.79% 2030 bond yield declined by 10 bps to 5.9%, while 6.45% 2029 bond yield declined by 8 bps to 6.04%. 5-year benchmark 5.22% 2025 yield decreased by 6 bps to 5.24%. 6.19% 2034 yield level came down by 10 bps to 6.28%. Long term paper 7.16% 2050 yield declined by 4 bps to 6.74%

The spread of 10-year bond over 5-year bond (5.22% 2025) decreased to 66 bps from 70 bps. The 15-year benchmark over 10-year benchmark spread rose to 39 bps from 37 bps. 30-year benchmark over 10-year benchmark spread increased to 65 bps from 62 bps.

In the weekly SDL auction, the average 10 years SDL cut-off yield remained flat at 6.9%. Spread over benchmark 10-year yield rose marginally to 87 bps from 84 bps of previous week auction.

One-year OIS yield came down by 6 bps to 3.75% while the five-year OIS yield declined by 6 bps to 4.43% on a weekly basis.

System liquidity as measured by bids for Repo, Long Term Repo, Reverse Repo, Term Repo and Term Reverse Repo in the LAF (Liquidity Adjustment Facility) auctions of the RBI, drawdown from Standing Facility (MSF or Marginal Standing Facility) and CMB was in surplus of Rs 2693 billion as of 08th Oct 2020. Liquidity was in a surplus of Rs 2096 billion as of 1st Oct 2020.