RBI new G-sec buying plan hits bond yields

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  RBI new G-sec buying plan hits bond yields

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• The story: The RBI’s 2021 decision to increase the purchase of government securities (G-Secs) under the new government securities acquisition programme (G-SAP - essentially note printing programme) has now led to the yield on the benchmark 10-year bond falling below 6%.
• Recent bond yield: In April 2021, the RBI launched G-SAP under which it said it would buy Rs 1 lakh crore worth of bonds in the April-June quarter. It bought Rs.25,000 crore worth of government securities (G-secs) in first shot, and the 10-year bond yield declined 15 basis points from 6.15% in one month (April).
• Impact: Movements in yields, which depend on trends in interest rates, can result in capital gains or losses for investors. If an individual holds a bond carrying a yield of 6%, a rise in bond yields in the market will bring the price of the bond down. A drop in bond yield below 6% would benefit the investor, as the price of the bond will rise, generating capital gains. Note that bond prices and bond yields move in opposite directions (while nominal interst on a bond remains fixed throughout). The G-SAP has engendered a softening bias in G-sec yields which has continued.
• Bond yields softening: The fall in bond yields in India could also be due to a sharp decline in US Treasury yields or the economic uncertainty caused by Covid-19. The important driver of the bond market was RBI interventions, like the announcement of a bond-buying programme, the G-SAP, at the start of the month. The RBI continued to send strong yield signals by cancelling and devolving government debt auctions. In the last month alone (April 2021), the RBI cancelled more than Rs.30,000 worth of debt auctions. A part of this amount was offset by availing the green-shoe option (option to accept bids for more than the notified amount of debt auction) in other securities. Yhe decision to buy Rs.35,000 crore worth of bonds in May 2021 would help the market absorb a portion of the Rs.1.16 lakh crore market borrowings by the government during the month.
• Impact on markets: The structured purchase programme has calmed investors’ anxieties, who always wanted a timeline on govt. borrowings. It reduced the spread between the repo rate and the 10-year government bond yield. A decline in yield is also better for the equity markets because money starts flowing out of debt investments to equity investments (total investible funds being fixed, investors need to decide where to invest). This means that as bond yields go down, the equity markets tend to outperform by a bigger margin, and vice versa.

1. When bond yields go up, the cost of capital goes up as overall interest rates start rising in the economy. So, when bond yields go up, it is a signal that corporates will have to pay a higher interest cost on debt.
2. As debt servicing costs go higher, the risk of bankruptcy and default also increases. This makes mid-cap and highly leveraged companies vulnerable.

• Why is RBI forcing yields lower: The RBI aims to keep yields lower because this reduces borrowing costs for the government. It also prevents any upward movement in lending rates in the market. (A rise in bond yields will put pressure on interest rates in the banking system, leading to a hike in lending rates.) The RBI wants to bring down the cost of government borrowing for 2021-22, which is set at Rs 12.05 lakh crore. Given the massive second Covid wave, it is bound to be higher.
• Summary: The US monetary policy's future direction and Fed bond yields are risk factors for the Indian bond market in 2021. Overall, bond yields may remain in a tight range in near future supported by RBI’s bond purchases. Inflation and potential monetary policy normalisation will play a more important role. Market interest rates may move higher gradually over the next 1-2 years.

Read more on - Polity | Economy | Schemes | S&T | Environment

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