How RBI’s liquidity and bond market moves will help ease rates

As was widely expected, the RBI held its key policy repo rate at 4 per cent. But by retaining its accommodative stance and giving a ‘whatever it takes’ assurance to revive growth, the RBI managed to cheer the market. The central bank also announced a slew of measures to ease bond market concerns, which will help keep yields under check and augur well for transmission. Here's a deep dive into the various measures announced by the RBI.

On tap TLTRO

The measure

The RBI has decided to conduct on tap TLTRO with tenors of up to three years for a total amount of up to ₹1,00,000 crore. The scheme will be available up to March 31, 2021. Liquidity availed by banks under the scheme has to be deployed in bonds issued by the entities in specific sectors (details awaited). Investment made by banks under this facility will be classified as held to maturity (HTM), implying banks need not mark-to-market these investments.

Will it work?

The RBI had first announced targeted long term repo (TLTRO) of ₹1 lakh crore in March. Banks were to deploy these funds in investment grade (BBB rated and above) corporate bonds, commercial paper, and non-convertible debentures. While the MTM leeway resulted in good response for TLTRO auctions, the funds did not flow into the much-needed vulnerable small and mid-sized corporates and NBFCs and MFIs. The deployment of funds was largely to bonds issued by public sector entities and large corporates. Subsequently, the RBI decided to conduct TLTRO 2.0 for an aggregate amount of ₹50,000 crore, wherein funds had to be invested by banks in investment grade bonds of NBFCs, with at least 50 per cent towards small and mid-sized NBFCs and MFIs.

But this move too, failed to offer much relief for small-sized NBFCs/MFIs. This is because of the over 9,000 NBFCs and MFIs only about 4-5 per cent are in investment grade (BBB and above rating). Also within the investment grade, banks prefer to invest in entities with minimum A ratings.

This time around, the RBI has announced that the bonds issued by entities in specific sectors will be eligible under the scheme. While details on this is still awaited, the success of the scheme would still depend upon individual banks’ risk appetite and capital position. Despite the MTM leeway, some banks may still remain risk averse to lend to NBFC/MFIs. Also, the TLTRO pertains to investment grade bonds. The low rated and really stressed NBFC/MFIs could continue to face liquidity issues.

But from a bond market perspective, the TLRO will help ease yields on three-and five-year government bonds which have been inching up since the July lows (by about 25 bps). This is very important as movements in yields of these shorter tenure bonds only get transmitted to other bonds, and finally to loan rates. The RBI’s TLTRO move can hence help ease transmission.

Extension of HTM dispensation

The measure

In a bid to ease the risk aversion, the RBI had eased the HTM holding norms for banks on incremental purchases of government bonds (SLR securities) from September onwards. Essentially, bonds held under HTM need not be marked to market. By hiking the HTM limit for banks by 2.5 per cent (of deposits) for the second half of this fiscal, the RBI had created an additional ₹3.6-lakh crore of buying window for banks, without having to worry about the fluctuation in bond prices.

Now the RBI has extended the dispensation of enhanced HTM limits up to March 31, 2022 for securities acquired between September 1, 2020 and March 31, 2021.

Will it work?

The biggest overhang for the market has been the oversupply of government bonds in the second half of the fiscal owing to the Centre’s increased borrowings. While the Centre has retained its borrowings for the entire fiscal to ₹12 lakh crore, expectations are that there will be increase of ₹2-2.5 lakh of borrowings towards the end of the fiscal to bridge the revenue shortfall. Given that FPI interest has been very weak, concerns over the absorption of the supply of bonds has been adding upward pressure to bond yields.

By extending the HTM dispensation until March 2022 for banks, the RBI has created an additional buying window for banks without having to worry over treasury losses for a longer time. This should aid bond yields, which have already come down by 10 bps post the announcement.

More OMOs in G-Secs and special OMOs for SDLs

To ensure comfortable liquidity and ease the upward pressure on bond yields, the RBI has announced outright OMOs (purchase of government bonds) to the tune of ₹20,000 crore per auction. The RBI has also announced OMOs for the first time for State Developments Loans (SDLs) as a special case.

Will it work?

The RBI has been largely able to manage long-term government bond yields through operation twist (essentially a liquidity neutral move involving buying of long-term government paper from proceeds of sale of short-term securities). But the RBI’s first outright open market operations (OMOs) — purchase of government bonds — for this fiscal amounting to ₹10,000 crore, had come a cropper. The RBI had rejected all the bids as they came in at a yield or price unacceptable to it.

Hence, how far the ₹20,000-crore outright OMOs succeed will need to be seen. But on the positive side, the RBI’s OMOs sends strong signal to the market on its willingness to keep yields under check. This is a huge positive for the bond markets.

Along with the concern over increase in central government borrowings, bond markets have also been on the edge over the sharp rise in state borrowings towards the end of the fiscal. Remember, only about 30 per cent of the overall borrowings of about ₹9.6 lakh crore for FY21, has been completed so far. By announcing an outright OMO purchase of SDLs, the RBI has eased bond market concerns over the absorption of excess supply of SDLs.