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RBI operation Twist and OMO, buying in secondary markets- will it take the ten year below 6 % levels.

Murthy Nagarajan

By Murthy Nagarajan,
Head-Fixed Income, Tata Asset Management
Publication: Economic Times.com

RBI operation Twist and OMO, buying in secondary markets- will it take the ten year below 6 % levels.

After the RBI monetary policy minutes release, the bond markets entered into a bearish mode, with ten-year bond yield traded above 6 % levels. This is after RBI has taken measures to control bond yields. RBI has done Rs 40000 crores of operation Twist, increased HTM limits for Banks from 18 % to 22 % for approved Government securities. RBI has also devolved the ten-year bonds around 6 % levels on primary dealers, when ten-year yields was trading 10 basis points higher in the secondary markets.

It all started with RBI initial silence/ no action when the ten-year yields moved above 6 % after RBI monetary policy decision. RBI have done operation twist/OMO, whenever the ten-year yields have done above 5.90 % levels, markets have been accustomed to RBI intervention at 5.90 % levels. The Debt Markets had a rude shock, when RBI devolved the ten year below 6 % and did not follow up with Open Market Operation/ Operation Twist. The ten-year yield touched 6.25 % levels, as traders started shorting markets due to huge supply of government securities and as markets started factoring no RBI actions to control yields.

Even after a series of measures was announced by RBI, there is investor disinterest as most of the primary auction purchases of Rs 6 Lakh crores in the current financial of the year are in losses. Around 3 Lakh crores of state government papers are also bleeding the Investors, who have purchased in the secondary markets.

RBI monetary policy committee has expressed concern over CPI inflation. CPI Inflation has been above 6 % for the last 6 months. The trajectory of CPI inflation is not expected to go down to 4 % levels, till the 4th quarter of this financial year. RBI is allowing currency to appreciate to control imported inflation However, food inflation continues to be around 10 %, with prices of vegetables flaring up, due to excess rains in Maharashtra and other parts of the country, which has damaged crops. The last CPI inflation reading of 6.70 % seems to be peak of CPI, as from September onwards, we have high base effects and unlocking of the economy should led to free flow of goods and services. The government has taken measures like banning onion exports and more such measures may be in store to bring down prices of agricultural products. However, these measures will take time.

RBI has intervened in the secondary market by purchasing Rs 2650 Crores from Sept 11 to 13,2020 as per data released by RBI. RBI has also allowed banks to refinance the Long-term repo operations of 3 years of Rs 1.25 lakhs crores, taken from RBI at 5.15 %. Rs 1.22 Lakh Crores has been repaid and not refinanced as the operating rate is the reverse repo rate of 3.35 % and system liquidity is above Rs 3 Lakh crores . This will allow RBI to do more OMO and secondary market purchases to control the 10-year yields, from moving above 6 % levels. We can expect the Long-term Repo of Corporate Bonds also to get refinanced in the coming days.

The Central Government revised borrowing is Rs 12 Lakhs crores, the Government has already borrowed Rs 7.06 Lakhs crores in the first half of the financial year. The Balance borrowing programme is 5 Lakh crores. Given the Revenue shortfall, and supplementary demand placed by the finance minister of Rs 1.69 Lakh crores, it seems the government will borrow addition Rs 2 Lakhs crores from the market. This can happen either through additional borrowing or through monetization of deficit. CPI inflation is also expected to go lower in the coming days due to high base effect and arrival of Rabi crops. For the bearish sentiments to subside, CPI inflation has to come below 6 % in the coming months, giving RBI room to be aggressive in its Secondary market purchase and OMO. RBI can also monetise the additional borrowing programme of the government, to take out the additional supply from the markets.

Global interest rates are benign with the Federal Reserve stating it is not going to raise rates till 2023. India’s Economy growth is expected to be negative 7 % in the current financial year, RBI needs to do support economy recovery by bring down rates in the economy. Banking sector deposit growth is 11 % and credit growth is 5.5 % on a year on year basis. Given heighten risk aversion, lower rates will not led to demand side inflation as capacity utilization rates is below 60 % in most industries.

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