RBI Watch: Managing bond supply a necessity, not largesse

Thursday, Jul 2, 2020


By Pratigya Vajpayee


Since the beginning of the current financial year, the bond market has been hankering for the Reserve Bank of India's support towards the government's borrowing programme. Especially since the sharp increase in the Centre's borrowing for 2020-21 (Apr-Mar) was announced on May 8, the market has been waiting for the RBI to step in and absorb a part of the bond supply, or at least announce measures to keep a lid on yields.


After a long wait, the central bank today conducted special open market operations aimed at cooling off long-term bond yields, and about time too. This was only the second such operation carried out since the beginning of the current financial year, a period in which the government has saddled the market with bonds worth nearly 3.5 trln rupees.


A large portion of this supply now rests with banks, especially state-owned lenders, leaving them with bloated investment books.


Latest data showed investments of scheduled commercial banks amounted to 29.8% of their deposits as on Jun 5, an increase of over 250 basis points since the beginning of the year. In the corresponding period last year, this ratio had risen by less than 100 bps to 27.9%.


The government has not even conducted 30% of its borrowing programme for 2020-21, and banks are already said to be running out of space in their held-to-maturity portfolios which are exempt from being marked to market. This implies that banks are now increasingly vulnerable to a rise in bond yields, with their exposure rising with every successive weekly bond auction conducted by the government.


In such a scenario, any rise in yields would entail huge losses for public sector banks because of the large size of their investment books. The consequent damage to risk appetite could turn banks averse to holding on to bonds and send yields surging further. With India's financial system already facing much turbulence amid the COVID-19 pandemic, large scale losses on bond portfolios would prove to be catastrophic for financial stability.


Given these stakes, it will not even take a sharp rise in yields for banks to start feeling nervous about buying bonds. All it will take is for yields to stop falling, and gradually drifting higher.


The last time when banks' exposure was this high was the post-demonetisation period in 2017, when a sudden flood of surplus liquidity forced banks to load up on bonds to maintain the mandated level of statutory liquidity ratio. However, banks' capital buffers were not running as thin. Between then and now, banks have seen multiple corporate write-offs which means that their present view on capital is very different from what it was around two years ago.


Moreover, banks have also learnt a bitter lesson from the losses that they suffered on bond holdings in 2017-18.


One can understand the RBI's reluctance in taking outright measures to lower the government's cost of borrowing and bestow trading gains upon bond market participants. At another time, the central bank's intervention could pose a moral hazard. At the current juncture, it's the need of the hour.



* RBI extends leeway on CRR maintenance, use of SLR for MSF by 3 mos

* RBI board discusses COVID, fincl yr change but not 1-time loan recast

* RBI writes to govt to extend term of MPC's external members by 6 mos

* Fitch lowers India's rating outlook to negative, affirms BBB- rating

* S&P affirms India at BBB-, but expects meaningful fisc gap fall FY22

* Moody's downgrades India's ratings to Baa3, retains negative outlook

* MPC members sound potential growth alarm, see econ being set back yrs

* MPC Ghate says govt between rock and hard place, but caution needed

* MPC meets out of schedule again, cuts repo rate to 4.00% 
* RBI says to support smooth completion of Centre, state borrowings 
* RBI sees India FY21 GDP growth likely to be in negative territory 
* Das says can fashion new tools, rate cut headroom present 
* Extends moratorium on term loans by 3 mos till Aug 31

Repo Rate: 4.00%
Reverse Repo Rate: 3.35%
Cash Reserve Ratio: 3.00%
Bank Rate: 4.25%
Marginal Standing Facility Rate: 4.25%
Statutory Liquidity Ratio: 18.00%




Edited by Avishek Dutta


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