RBI withdrawing OMO pushed up bond yields
The government bond market reacted negatively to the CRR cut with bond yields rising by 25bps from lows of the day. Ten year benchmark bond, the 8.79% 2021 bond saw yields rise from 8.15% levels to 8.35% levels at which it closed. The reason for government bond yields moving up was due to the fact that the RBI is likely to stop government bond purchases through Open Market Operations (OMO’s) as the CRR cut will add Rs 32,000 crores into the system. RBI was using OMOs as a liquidity tool and they had already purchased over Rs 70,000 crores of bonds over the last couple of months.
The RBI buying of bonds had added a sense of complacency in the market and the market was comfortable bidding for government bonds at lower levels of yields. The last bond auction on the 20th of January saw the cut off on the 8.79% 2021 bond coming in at 8.14%, the lowest level of yields seen in over seven months, largely on the sense of comfort given by the RBI bond purchases.
The RBI’s absence will be felt in the coming weeks, as the market has to absorb the supply of government bonds without the central banks help. The withdrawal symptoms have already taken its toll on bond yields post the credit policy and auctions will now see pain for bond yields.
Bond yields will however, not rise above 8.50% to 8.6% levels as markets will look at RBI easing policy rates in March and there will be good buying at lower levels of yields.
The rise in bond yields is a wake up call for the RBI and the government as RBI bond purchases is a back door deficit financing and once the lifeline of the central bank is removed, the pain starts.