RBI likely to let market determine 10-year bond yields, say analysts

Given the massive fiscal expansion scheduled for the next financial year -- Rs 12 lakh crore of government debt papers are set to flood the market -- analysts are of the view that the RBI is likely to let the market determine the yields and may not fixate on keeping the 10-year yield below 6 per cent as it did in 2020.

This would indicate that the Reserve Bank is moving towards a new equilibrium for yields, something Governor Shaktikanta Das considers as a "public good".

The RBI left the policy rates unchanged as expected but reiterated its accommodative stance both on the interest rate as well as more importantly on the liquidity side for as long as it takes.

"Yield curve is a public good," said Das, while allowing retail investors direct entry into the government securities (G-secs) market.

"Though yield management by the RBI is likely to continue, the central bank is likely to be more comfortable with a higher band for yields than 2020, Abheek Barua, the chief economist at HDFC Bank said.

However, an accommodative stance does not imply the same level of systemic liquidity surplus and bond yields going forward, indicating the the central bank is moving towards a new equilibrium for yields -- which means allowing the market to determine the yields, he said.

The bond market finds itself in a new environment of better growth prospects, higher inflation risks, lower liquidity surplus and a significantly expansionary fiscal policy.

"These fundamental changes warrant a repricing of the yield curve towards a more 'fair and consistent' band with the underlying economic metrics," he said, adding this is likely to lead to the 10-year yield trading in the range of 6.10-6.20 per cent in H1.

The 10-year yields rose sharply to 6.153 per cent after the policy announcement from 6.07 per cent on Thursday.

While the RBI might continue to manage the yield curve through open market operations (OMOs) and 'operation twists' and more aggressive intervention in case the yield moves beyond 6.20-6.25 per cent, it is unlikely to fixate on keeping the 10-year below 6 per cent as it did in 2020, he said.

Soumya Kanti Ghosh, the group chief economic adviser at State Bank of India, quoting the governor who said "the yield curve is a public good and markets should appreciate it," said it is common to find debt market players behaving differently with one set of participants acting pro-cyclically with the monetary policy stance, others acting counter-cyclically and sometimes both acting combatively.

"Such combativeness may be inconsistent with signaling RBI stance and that is precisely what happened today. This is precisely why the governor again espoused yield curve as a public good today," he said.

However, Ramnath Krishnan, president - ratings at Icra held an opposite view, saying the central bank will not let the yields fly.

The accommodative policy stance is a strong signal of the RBI's intent to continue to cap yields, and allow an expansionary fiscal policy at the central and state level to cement the revival in economic growth, he said.

However, with the net supply of dated G-secs and State Development Loans (SDLs) projected at a massive Rs 16.5 lakh crore in FY22, and higher crude prices fuelling inflationary concerns, he expects frequent market operations will be required to assuage the bond market's concerns and prevent yields from rising.

"We currently expect the 10-year yields to range 6.1-6.2 per cent over the next three months," Krishnan said.