RBI policy: Inflation aside, stance on monetising government debt will be in focus

With persisting elevated levels of inflation, the Monetary Policy Committee (MPC) is expected to hold its key policy repo rate in the upcoming policy. But from a bond market’s perspective, the RBI’s view on yet another critical aspect (aside from inflation) is keenly awaited.

How does the RBI intend to manage government debt, amid growing possibility of further increase in borrowings and stand-off in recent auctions?

At the latest auction on Friday, of the total notified amount of ₹30,000 crore, ₹18,000 crore was with respect to 10-year government bonds (5.77 per cent GS 2030). While ₹28,345 crore of bids were received for the paper, only ₹125 crore was accepted at a cut-off yield at 6 per cent. About ₹17,800 crore devolved on primary dealers.

A similar stand-off was seen in the September 11 auction, where only bids worth ₹25 crore of the ₹34,141 crore bids received (₹18,000 crore notified amount) were accepted for the 10-year government security (5.77 per cent GS 2030). The cut-off yield then for the auction was 6.02 per cent. On August 28, only ₹4 crore of bids were accepted against ₹34,724 crore of bids received for the 10-year paper; the cut-off yield stood at 6.14 per cent.

Open market operations

Interestingly, the RBI’s first outright open market operations (OMOs) — purchase of government bonds — for this fiscal amounting to ₹10,000 crore, had also come a cropper. The RBI had rejected all the bids.

These auctions clearly indicate that the bids for the longer 10-year government bonds are coming in at a yield or price unacceptable to the RBI. The RBI is keen on keeping yields under check even if the market is increasingly worried over the rising government debt issue.

After the outright OMO falling through, the RBI announced a special OMO or operation twist (OT) of ₹10,000 crore (essentially a liquidity neutral move involving buying of long-term government paper from proceeds of sale of short-term securities). This can help in keeping yield on long-term bonds under check in the near-term, as it helps the RBI to anchor rates to its bidding.

But tools to manage both price and quantity of bonds in the market can only work in the short-term. To manage the more critical and long-term issue of piling government debt, the RBI will have to announce concrete measures to manage debt either indirectly through OMO purchases or directly by purchasing government securities in the primary market (by printing currency).

Oversupply of bonds

Despite the RBI’s tactical interventions through special OMOs and easing of HTM (held-to-maturity) limits for bond holdings by banks, the yield on the 10-year G-Sec has been inching up recently, hovering over the 6 per cent mark. This is about 200 basis points (bps) over the policy repo rate of 4 per cent and nearly 300 bps over the overnight call money rate.

The oversupply of bonds in the second half of the fiscal appears to be spooking the market, leading to upside pressure on the 10-year G-Sec.

The Centre had announced additional borrowings for FY21 in May, taking the total borrowings to ₹12-lakh crore from the earlier estimated ₹7.8-lakh crore. Given the widening fiscal deficit on the back of sharp shortfall in tax revenues and divestment (₹2.1 lakh crore target) proceeds, there are growing expectations of a further increase in borrowings, to be announced this week.

Hence, aside from its views on inflation trajectory, the RBI’s plan to manage government debt will be keenly awaited in the upcoming policy. A concrete and aggressive stance by the RBI on managing the debt issue not only this fiscal but also in the coming years will be critical.