Reserve Bank governor D Subbarao cooled the bond market on Friday assuring it that the aggressive government borrowings would sail through efficiently.

Bond market participants interpreted that message as RBI?s commitment to keep on lowering interest rates despite the high government borrowing that made rate cuts difficult for the central bank.

The bond market responded to the governor?s assurance with the yield on 10-year government securities ending lower at 6.19% on Friday, down from Thursday?s close of 6.53%. The drop broke an eight-week rising trend in yields. The yield on benchmark 2018 bonds had jumped a steep 167 basis points to 6.53% on Thursday when dealers factored in a rising government debt.

Yields on bonds rise when their supply increases. The government has in this fiscal sharply increased its borrowing to keep investments in the economy despite a global slowdown.

Trying to calm the market, the governor said in Mumbai: ?We will see (to it) that the market is stable. We will see (to it) that there is no volatility. We will manage the government?s borrowing programme in the most efficient fashion.?

What Subbarao meant was that rising bond yields in times of falling policy rates create the incentive for banks to park funds in government paper instead of lending to industry. Higher government borrowings also mean the central bank?s ability to cut rates is crippled.

Citing some ?structural factors? behind sticky interest rates, RBI has, in its third quarter review, said the ?persistence of the large market borrowing programme of the government hardens interest rate expectations.? This is counter-productive when the government and RBI are trying to lower interest rates.

The Centre has parliamentary approval to raise Rs 2,05,000 crore from the market for this fiscal, compared to Rs 1,56,000 crore in 2007-08. It has already raised Rs 1,90,000 crore. The government will announce a fresh borrowing programme for 2009-10 in the interim Budget on February 16.

?Things have got complicated,? said Rajesh Chakrabarti, finance professor at Indian School of Business. The longer term yield should ideally be moving closer to the repo rate, but actually it is moving away, he said. Repo, or the RBI short-term lending rate, is currently at 5.5%. Market yields surged despite RBI?s 350 basis points cut in the repo rate in the past four months.

As part of the cooling off process, bond yields on Friday fell on expectations that RBI would intervene by either buying the bonds directly from the government or buying them from the secondary market. Yields had hit an eight-week high of 6.53% on Thursday from 4.86% in early January.

RBI has already become active in the bond market. The bank bought Rs 45 crore worth bonds in the week to January 30 and sold Rs 44 crore of debt in the same week, according to RBI?s latest data. It had sold Rs 1 crore worth of bonds in the previous week while debt sales in the secondary market were nil, the data showed.

Asked whether private placement of bonds by the government with the central bank was an option, the governor said: ?At this point, we have not decided. We are discussing with the government on the amount that has to be borrowed and how we borrow it.? The government has not placed bonds privately with the central bank after March 2006.

With its oil and fertiliser subsidy bills expected to be lower because of the drop in international crude oil prices, the government?s borrowings for 2009-10 are likely to be at the same level or even lower than this fiscal. But the borrowing calendar will be finalised only after the new government takes charge and presents the full Budget in June. At that time expenditure allocations could be raised for various schemes.

?The Centre?s borrowings at present would be more or less the same as last fiscal. But this will change when the new government takes charge in June,? said Saumitra Chaudhuri, member, Prime Minister?s Economic Advisory Council. The council?s chairman, Suresh Tendulkar, said RBI would adjust rates after the interim Budget as there will be more clarity on government borrowings. ?The government?s borrowings will depend on the measures it decides to take for revival of the economy. RBI is awaiting the vote-on-account and the government?s borrowing requirement. It will then assess the impact on the liquidity supply and then adjust rates,? he said.