Reserve Bank of India changes methodology to ensure bond auction success

Adopts uniform price auction for bonds up to 14 years till further notice

The Reserve Bank of India (RBI) on Friday changed its bond auction methodology and said till further notice, bonds maturing between two to 14 years would be auctioned under ‘uniform’ price method, and not multiple price method.

“On a review of market conditions and market borrowing programme of the government, it has been decided that benchmark securities of tenor 2-year, 3-year, 5-year, 10-year, 14-year tenor and Floating Rate Bonds (FRBs) will be, henceforth, issued using uniform price auction method,” the RBI said in a notification on its website, adding the 30-year and 40-year bonds will be auctioned under the established multiple price method.  

In a uniform price method, all the market participants are allotted bonds at a uniform cut-off decided by the bidding pattern. This is usually the rate closer to the market. In a multiple auction scenario, there is a bidding competition, and there is an uncertainty of not getting the bonds. The uniform price auction helps the bidders in a rising interest rate scenario (when prices are falling), and as a result, the auctions are easily conducted. In multiple price auction, in a rising rate scenario, the issuer (RBI) benefits, as it expects the markets to bid at higher rates (and lower price) per bond.  

The uniform price method also leaves out frivolous bidders as the chances of getting the bonds increase. This helps the RBI to sail through the auction at a better price when interest rates are rising, such as now. 

The bond market is witnessing increasing devolvements, or forcing the underwriters to buy the bonds, in this financial year.  For example, On Friday’s auction, the RBI forced the primary dealers to buy Rs 10,495 crore of the 5-year bond, out of Rs 11,000 crore auctioned. The RBI raised Rs 34,500 crore in Friday’s auction, including the devolvement on primary dealers.   The uniform method is required in such scenarios where tension is building up between the market and the RBI, say experts.

“Moving to uniform price-based auction suggests there is pressure on the interest rates to move up. With the uniform pricing, when there is pressure on rates towards upside, bidders will be least bothered about losing on the price, therefore they can bid fearlessly," said Soumyajit Niyogi, associate director at India Ratings and Research, adding, "This gives some comfort to yields at auctions.”  The RBI’s shift towards a uniform price method can be explained on the basis of an observation in the financial stability report (FSR) released on Thursday.   

The RBI observed that banks are now saddled with huge government bonds, which also make them sensitive to valuation changes.   

“Going forward, however, their absorptive capacity may be circumscribed by the likely expansion of bank credit in the wake of the recovery,” the FSR report warned. 

The RBI is now trying to increase retail participation in bonds, as well as pushing the government to tap into foreign investor base by allowing full access to some specified bonds.  

“While the RBI has rightly expressed that there might be limits to bank appetite in government securities, it might not be simple to diversify the basket. For example, banks currently contribute 38 percent and insurance companies at 25 percent, but preference of investment is different,” said Soumyakanti Ghosh, group chief economic advisor to State Bank of India Group. 

“Thus, if the markets have to diversify, there has to be a clear demarcation of bucket wise papers for different market players. Additionally, the basket may have to be broadened further with investment by other players like foreign investors, pension funds and others. For that, we might require changes in existing regulations,” Ghosh said.

The government bond holding by banks stood at their highest level in March 2021, since March 2010. In the second half of FY21, banks accumulated Rs 1.33 trillion of government securities (G-Sec) and Rs 73,573 crore in state development loans (SDL). Insurance companies were seen fast catching up with banks, increasing their Gsec holding by Rs 1.24 trillion and Rs 86,688 crore in SDLs. The secondary market operations by the RBI allowed it to increase its Gsec holdings by Rs 1.66 trillion, and SDL holdings by Rs 30,000 crore.