Operation Twist: The Indian Version
The Indian government's benchmark 10- year bond yield is down by 20 basis points (bps) in today’s trading. This is after witnessing a sharp decline of 2.19 per cent on Friday (December 20). The rally in bond prices in the last couple of days was seen after the apex bank of India announced its own ‘operation twist’ and said that it will buy Rs 10,000 crore of longer-tenor bonds while selling shorter debt. The intention behind this is to supply more of those securities where the liquidity is impacting the buying interest and, at the same time, absorbing those securities, where more liquidity is not leading to more demand.
On December 19, the Reserve Bank of India (RBI) announced that on December 23, it will conduct a simultaneous sale and purchase of Rs 10,000 crore of government securities of the varying tenor. While it will sell short-term bonds of Rs 10,000 crore, it will also purchase long-term securities of the same value. This will help in bringing down the long term yield and correct the steepening of the yield curve. In the last year, RBI had cut key policy rates by 135 bps; however, the bank has transferred only a part of that to their customers. The one-year median marginal cost of funds based lending rate (MCLR) has declined by only 49 bps. The spread between 10-year bond yield and the repo has widened to 170 bps (before the current fall) and this is more than double the average in the last couple of years.
As RBI will buy long-term bonds, its demand will go up and yields will go down. The opposite will happen when it sells bonds, which will help in correcting the anomaly in the yield differential. This move of the RBI will bring down the long term cost of borrowing, which may help corporates in taking investment decisions. Moreover, with the long-term yields coming down, the government will be able to borrow money on cheaper rates against its bonds.
Going ahead, looking at the government’s fiscal position, we believe RBI may announce more of such activities. Nevertheless, more clarity will emerge only after the union budget.