The Monetary Policy Committee left rates unchanged and continued on Friday to maintain an accommodative stance. The governor went to great lengths to “not shake the boat” as he said, especially with the shore (end of the pandemic) in sight and given the need to prepare for the trip to the -beyond the pandemic. But bond markets weren’t too impressed, with the 10-year G-Sec yield tightening 5 basis points to close at 6.318% on Friday.

Difficult balance

The central bank has a difficult balancing act to begin to move towards policy normalization like other central banks while ensuring that the economy and markets are not disrupted.

The rising excess liquidity means it cannot continue to support the bond market. The excess liquidity averaged 9.5 lakh crore in October, compared to 7 lakh crore from June to August.

Two measures were announced to manage the surplus and short-term rates. First, other G-SAP auctions have been halted, although the central bank has said it will hold G-SAP auctions and other liquidity management tools such as twist and open market operations, if needed.

Second, he plans to increase the quantum of 14-day VRRR bids to raise it to ₹ 6-lakh crore by December and conduct a 28-day VRRR, if necessary. The Governor assured that even with that, the liquidity absorption under the fixed rate reverse repurchase agreement would still be ₹ 2-lakh crore to 3-lakh crore by December.

The stopping of G-SAP auctions is negative for the bond markets as it reduces the absorption of G-Secs to this extent.

Focus on other tools

While the central bank promises to use other tools to balance supply, the G-SAP auctions have given visibility to bond markets, which is now being withdrawn.

VRRR auctions will not alter the liquidity of the system as the RBI is only trying to move existing liquidity to these auctions, where it will have greater control over rates; the intention is to drive up short-term interest rates. This should be a precursor to increasing the reverse repo rate in future policies.

The bond market is worried as supply will remain high despite falling demand.

With the need to sterilize capital flows, liquidity is expected to remain high. In addition, the market is not entirely convinced of the lower inflation projections.

“In the absence of sustainable absorption, short-term rates are unlikely to approach policy rates directionally. The market direction is expected to remain volatile as the excess additional policy measures persist.

“While national impressions of the short-term CPI may provide some relief, external factors such as commodity prices and the unwinding of global monetary deals could offset this,” said Rajeev Radhakrishnan, CIO – Fixed Income, SBI Mutual Fund. “Liquidity management is also crippled by the unwinding of RBI term premiums of up to $ 23 billion in the past two months.

“If the RBI is to discourage cash injection instead of such an unwinding, as the MPR notes, the resulting turnover can trigger a vicious cycle of higher inflows and even more increases in term premiums. “, notes Soumya Kanti Ghosh, chief economic adviser of the group. , SBI.

Global risk aversion

Additionally, if global risk aversion increases, there could be larger REIT outflows from G-Secs, putting upward pressure on yields. With all of these favorable winds, bond yields may rise slightly over the coming week.