To be sure, banks are inundated with funds; loan growth has been anaemic, at just about 5.5% year-on-year, while deposits are galloping along at 10-11% y-o-y.
With the Reserve Bank of India (RBI) saying it would trade short bonds for long bonds in what is called an “Operation Twist’, and also Rs 20,000 crore worth of OMOs, the benchmark yield fell four basis points on Tuesday, to just over 6.13%. One would have expected the bears to retreat further. But the markets are clearly nervous given how the repo rate was left unchanged in early August and especially how the commentary from the Monetary Policy Committee was less dovish on inflation. What seems to have given the market the jitters is the central bank offering higher-than- expected yields at a debt auction last Friday and the demand at the previous auction falling short. Tuesday’s announcement doesn’t seem to have soothed the frayed nerves entirely; yields had climbed by 30 basis points to four-month highs, but haven’t retracted too much. This suggests the selling could continue unless RBI reassures the markets there are more OTs or OMOs on the way.
To be sure, banks are inundated with funds; loan growth has been anaemic, at just about 5.5% year-on-year, while deposits are galloping along at 10-11% y-o-y. This trend should sustain because banks are not inclined to taken on too much loan exposure in this extremely challenging environment or even via the corporate bond market. But the fact is the supply of paper has been fairly heavy, and it is no secret that the fisc is severely strained. The government may well tap the bond markets for a lot more than the Rs 12 lakh crore it has planned to borrow and state governments too will need funds.
Again, there are large surpluses parked with RBI’s reverse repo window that offers banks just 3.35%. These could be used to buy government securities. However, while banks have been hoping RBI will allow them to hold a bigger share of their bond portfolios in the ‘held to maturity” or HTM category, that concession hasn’t come through. Given how they are already holding way beyond the mandated levels, a spike in yields would mean losses on their bond portfolios, which they can scarcely afford. Even a slight increase in the Centre’s borrowings could drive up the yields.
The difference between the tone of the policy statement and the MPC minutes—even if it is a slight one—has rattled the markets. If yields don’t climb down by 15-20 basis points soon, it will cause an increase in rates across products, including corporate bonds. That, then, would hurt the transmission of the reduction in repo rates—a cumulative 250 basis points since February 2019—into lending rates, and would be a big blow to the economy. The central bank must try and prevent interest rates from going up.