The Reserve Bank of India may have to resort to unconventional tools to control the surge in bond market yields even as significant increase in bond spreads is a manifestation of the nervousness of market players, according to a report by State Bank of India economists.
The report notes that the central bank’s strategy of devolving on the primary dealers (PD), which in turn helps to rein in bond yields may have its limitations as standalone PDs account for 15-16% of secondary market share that may not be enough to move the market. This share has remained broadly consistent over long period despite excessive market volatility.
Yields on benchmark securities have surged over 30 basis points since the government budget earlier in the month and hovering above 6 percent despite an accommodative stance and abundant liquidity in the system. “We believe one of reasons for the recent surge in yields might be short selling by market players. While going short or long are typical market activities that aid in price discovery” said SK Ghosh group chief economic advisor at
. “But in times it can result in price distortions too as it might be happening now”. Short selling involves the sale of a security which the seller has not yet purchased but borrows the security from others in the market.
The only way out is that the RBI could conduct large scale open market operations to provide necessary steam to bond market to rally and with increase in price, many short sold position will trigger stop losses and market players will scramble to cover open positions. This will hasten a rapid fall in yields over a short period of time.
Besides, speaking to the market players, central bank could conduct OMO in illiquid securities, impose margin requirements, allow more players and penalise short sellers among others. These measures are essential as surge in yields could result in mark to market losses for eligible securities and also bank profitability to an extent, the report noted.