10-year bond is no longer the rate signal for the economy, say experts

As the Reserve Bank of India (RBI) continues hoarding the benchmark 10-year bond, the security's shortage in the market is giving rise to some unique challenges. It is not the most-traded paper anymore, but more importantly, say bond dealers, the 10-year bond is no longer the rate signal for the economy.

Most of the 10-year security is now with the RBI, and a segment of the bond market says the central bank must increase the liquidity of this segment. That can happen if the RBI issues more of these papers, even as it is nearing its traditional issuance limit, or by selling the bonds in the market through market intervention methods.

If need be, the RBI could consider delaying the introduction of a new 10-year benchmark, say some bond dealers.

The 5.85 per cent, 2030 maturity paper is technically not the benchmark 10-year. It was issued on December 1, 2020, and therefore, technically is a 9-year paper now. But it is treated as the benchmark as a new 10-year paper has not been issued yet.

However, even if a new benchmark is issued, it will take time for tradable volume to build up in the paper. The bond in question has an outstanding volume of Rs 1.05 trillion. Typically, when the government raises just about Rs 1.20 trillion from one particular paper, a fresh set of bonds is issued. Therefore, a new benchmark is almost due in the normal course of business.

But bond dealers are not sure if that would be a good thing to do.

Managing Yield

• More than half of the existing 10-year bond is with the RBI
• The 10-year yield has remained around 6% as it is controlled
• 10-year bond is no longer the most traded bond
• Market wants the RBI to increase supply of this paper before issuing a new one

“Given the floating stock of 10-year in the market, it has become necessary to increase supply of the existing paper. Otherwise, it will be difficult to conduct G-SAP in benchmark and the yield curve will be distorted,” said Soumyajit Niyogi, associate director at India Ratings and Research.

The most traded in the market is now a bond maturing in 2035, while the 10-year is in the third position in terms of volume. Of the Rs 19,541 crore traded in the government securities market on Wednesday, the volume generated by the 10-year bond was only Rs 1,770 crore, while a bond that was last year’s five-year benchmark is the most traded one with a volume of Rs 5,045 crore. A new benchmark 5-year paper was issued on April 12, which is now the second most traded paper in the market, with a volume of Rs 3,630 crore.

The reason why the secondary market volume in the 10-year segment has dried up is because the RBI now holds more than half of the bonds on its own books. This helps it control the yields, and goes well with their effort to keep the 10-year bond yields at around 6 per cent or below.

Even as RBI Governor Shaktikanta Das said keeping the 10-year yields around 6 per cent was not the objective, but rather an orderly evolution of the yield curve, bond dealers are not sure if constricting the liquidity of one particular bond serves the purpose. The RBI has accumulated the bonds through various open market operations, and even through government securities acquisition programme (G-SAP). In planned secondary market operations, through G-SAPs or open market operations (OMOs), the RBI has officially purchased Rs 54,500 crore of the 10-year paper. It could have bought more in the secondary market as part of its intervention strategy, say bond dealers.

Even then, when the market bids were not favourable to the RBI, it forced the underwriters of the bond auctions on May 28 to buy the entire stock of Rs 14,000 crore as the central bank refused to sell it directly to the market. This has taken away interest in the paper even more. Even as the yields closed at 6.01 per cent, bond dealers say, it is optics and does not reflect reality.

Indeed, “it’s a difficult trade-off for the RBI between ensuring market liquidity and maintaining close control over 10-year yield,” said A Prasanna, chief economist of ICICI Securities Primary Dealership. However, the issue here is that even when a new 10-year bond comes, the same strategy could be pursued by the RBI, which cuts off the 10-year segment from market realities, say bond dealers. 

So, it does make sense for the RBI to postpone issuance of a new 10-year bond and issue more of the existing one.

“The new 10-year, when issued, will take time to build up in volume. The coupon of the new 10-year bond would be more than the existing 5.85 per cent. That would be a difficult rate signal to handle. Besides, if the bonds are with the central bank anyway, the government shouldn’t be too concerned about bunched up redemption,” said a senior bond trader requesting anonymity. Both the government and the RBI did not want to comment on this issue.

With inputs from Shrimi Chaudhury