As government cuts borrowings, RBI may sell more bonds to fight inflation

MUMBAI: With the government trimming borrowings in the second half and revenues showing an uptick, the Reserve Bank of India (RBI) may have to sell more bonds in the market to keep rates high to meet its goal on inflation.

The RBI may become more active in the secondary bond market in the coming weeks as it battles a flood of overseas fund flows.

On October 8, it announced the sale of government bonds worth Rs 10,000 crore on October 13 through open market operations (OMOs), a form of auction. The RBI had last sold government securities in an OMO on July 18 last year for Rs 12,000 crore. The move, which will add to supplies of government securities while draining money from the system, contrasts with the RBI’s current practice of OMO purchases, which infuse liquidity into it.

“The mechanism of conducting OMOs for government bond sales could either be a rate signal or a move to create a yield curve in government bonds,” said Ashish Vaidya, executive director and head of trading and asset-liability management at DBS Bank. “This move can actually help build the yield curve by widening the gap between short-term and long-term rates.”

“Offering long-term bonds, which results in higher yields in longterm rates, will incentivise longterm savers and reduce term mismatches in the banking system,” he said. While commercial paper below one year is offering around 8.50-8.55%, 10-year benchmark bond yields are hovering about 10 basis points below that. A basis point is 0.01 percentage point.

The RBI wants to keep rates high to win the battle against inflation. It will auction four long-term bonds with maturities of three, seven, 12 and 13 years in the OMO.

The immediate impact is reflected in benchmark government bond yields. After rallying in the last few trading sessions, the 10-year yield rose seven basis points to 8.48% on Thursday from 8.41% a day earlier before closing at 8.46%. On Friday, it was little changed. Bond yields and prices move in opposite directions. “The success of the latest OMO sales should determine its future course,” said S Ramasamy, chief investment officer, debt, at LIC Nomura Mutual Fund. “The ground reality is that borrowing costs are coming down even though it may be contrary to the RBI’s current stance.”