The Headline in the Times of India scream “Rs 4000 crores of Gilts Unsold”. The headline is factually incorrect as all government bond auctions are fully underwritten and no auction can fail. The paper wanted to sensationalize the fact that the RBI partially devolved the Rs 15,000 crores (27% of auction was devolved) on to the underwriters of the bond auctions, the Primary Dealers (PD). The Rs 15,000 crores auction received bids worth 1.58 times the auction amount indicating that the RBI could have let the auction clear fully to the bidders if it wanted to do so. RBI devolved the auction partially on to the PD, as it did not want to clear the auction at higher levels of bids in terms of yields.
Times of India incorrect headline apart, the fact that the bond markets are showing extreme negative reaction to Rajan’s first policy statement made on the 20th of September will test the new Governor’s ability to handle market reactions to tough policy decisions. Ten year benchmark bond yields have risen by 60bps from pre policy levels of 8.17% on the back of the repo rate hike of 25bps. The demand for the Rs 15,000 crores auction held post policy was low as compared to all previous auctions where the bids were over 2 times the auction amount.
Bond market is showing its concern over the RBI policy by taking up bond yields. The market is factoring in more repo rate hikes, lack of OMO (Open Market Operations) purchase auctions and uncertainty on when MSF (Marginal Standing Facility) rate will be brought down to 100bps over repo from current levels of 200bps over repo. Market is struggling with the restriction on banks access to the LAF (Liquidity Adjustment Facility) window for funds, which is capped at 0.5% of NDTL. High cost of funds, rate hike fears and continuous bond supply through auctions are leading bond yields higher.
The next bond auction is scheduled for the 27th of September. The fact that the auction size is reduced by Rs 1000 crores from Rs 15,000 crores to Rs 14,000 crores will make no difference to the bidding in the auction. The market is going to bid negatively in the auction and the RBI will have either have to devolve the auction on to the PD, prompting more factually incorrect but sensational headlines such as “Bonds go unsold in the auction” or will have to reject all bids outright.
Devolving auctions or rejecting bids in auctions does not help, as there is an auction scheduled almost every week starting October 2013. The government, much to the markets relief, has stuck to its budgeted borrowing schedule and is borrowing Rs 235,000 crores in the October – March 2013 period. The government will be auctioning Rs 15,000 crores of bonds in every auction for the next four months.
Rajan will have to clam markets down if he wants government borrowing to go through smoothly. RBI handles all the borrowing for the government and it cannot have a situation where the markets bid with fear in the auctions. As it is government bond yields at levels of close to 9% on the ten year benchmark bonds are trading at levels seen two years back when WPI inflation was over 9% levels and fiscal deficit was at trending at levels of 5.9% of GDP. Inflation in now at 6.1% levels and fiscal deficit is trending at 4.8% of GDP and bond yields should theoretically be trending down rather than higher.
Bond market will await some calming moves by the RBI as it goes into October auctions. Will Rajan oblige?