Why is bond market revolting and what can RBI do to pacify it

MUMBAI: India’s government securities market is in open revolt against the central bank, thanks to the government’s higher-than-expected borrowing plans for the current financial year and also the next.

As the debt manager of the government, the Reserve Bank of India (RBI) has promised to ensure a smooth borrowing programme and to keep borrowing costs as low as possible. Officials in the government are convinced the central bank will be able to help it borrow gargantuan sums at less than 6 per cent.

Bond traders think otherwise. They are now in open revolt against the central bank, leaving everyone to question if the apex bank has enough tools to quell this unrest. “To convince the market about its credibility and to manage the huge bond supply that we are likely to see in the year ahead, it is going to be a very-very tricky task for RBI,” Rajni Thakur, Chief Economist at RBL Bank, told ETMarkets.com in an interview.

The Centre plans to borrow over Rs 12 lakh crore from the bond market in 2021-22, which is substantially higher than what the market was prepared for. Seen in the context of rising inflation fears, spike in commodity prices and the surge in global bond yields, bond dealers are rightfully expecting the government to pay more for dumping such a large amount on their heads.

So what can the central bank do at a time when auctions for government securities are failing every week due to the market’s demand for higher yields?

Thakur expects RBI to use its communication channels to soothe the frayed nerves. RBI Governor Shaktikanta Das believes the same, as he told reporters after the latest monetary policy meeting that “the market will slowly appreciate it”. In the meantime, RBI has had to resort to measures like tweaking bond auction methods and indirect interventions in the bond market in an effort to keep yields under the lid.

“For RBI, it is a difficult position. At the short end of the yield curve, you want to push the rates up so that risk is priced in correctly. On the long end of the curve, you want to suppress the rates down, so that government borrowing costs are kept low,” Thakur said.

Thakur does not expect the storm to subside in the first half of next financial year, and believes tangible signs of sustained economic growth could perhaps come to the aid of the central bank, as rising tax buoyancy may eventually reduce the government’s need to borrow large amounts.

A Delhi School of Economics alumni, Thakur expects the 10-year benchmark bond yield to hover around 5.9-6.2 per cent in the first half of the next financial year, and them calm down to the 5.9-6.0 range, which is the preferred rate band of RBI, as signs of reasonable GDP growth become more prominent.


As the economy shows tangible signs of returning to the growth path after its worst two quarters in decades, there’s much debate about when the time may be appropriate for the central bank to withdraw its helping hand and bring normalcy to its policy.

RBI itself has projected real GDP to grow 26.2-8.3 per cent in the first half of the next financial year and by 6 per cent in the December quarter. However, with inflation expectations also rising, central bank watchers are worried that the apex bank may have to change its policy stance sooner than later.

For the market participants, who are trying to pre-empt the central bank’s reversal of policy stance and liquidity, the RBL Bank economist has a clue: “If we are back to 6% growth rate, which is materially higher than the pre-Covid growth rate, that would be the time to probably change from an ‘accommodative’ to ‘neutral’ stance, at least for the central bank to get comfortable with the growth path.”

She said while RBI may not be in a mood to cut interest rates any more, a rate hike is out of the question till the Monetary Policy Committee is abundantly comfortable about the sustenance of growth recovery.


Thakur says early signs of healing in the job market and a pickup in the informal economy are providing reasons for much optimism. “If this stays on track, I think we will fundamentally be on a high growth trajectory by September quarter of FY22,” she said.

A recent survey by Xpheno found that corporate sector is looking to increase recruitment as job vacancies surged 50 per cent in January over December as business owners become increasingly confident of the post-COVID recovery.

For India’s growth path to shift materially higher, Thakur suggests the recovery in the capital expenditure cycle is imperative and erratic government expenditure so far has not helped the cause. “There has to be a consistent pickup in government expenditure, which looks like the intention behind the Budget announcement, but that is yet to show on the ground. If that continues and the private capex cycle improves, then post-Covid potential growth rate could hit back to a 7 per cent level.”

In the absence of a recovery in capital expenditure, the economy’s long-term growth trajectory may go back to the mediocre 5-6 per cent level, Thakur said.

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