RBI strategy to counter fed tapering

  • Haunted by memories of India’s 2013 markets crash, the country’s central bank is engaging in a tricky balancing act with domestic yields to keep volatility out of its bond markets ahead of the Federal Reserve’s historic policy decision this month.
  • The Reserve Bank of India (RBI) is seeking to prevent wild swings in bond markets by agreeing to pay higher interest rates to investors at bond auctions while also buying bonds in the open market to stop yields rising too much.
  • Although India has outperformed many emerging markets this year, the country has not been immune to Fed jitters, with foreign investors selling around $1.7 billion in bonds and shares last month.
  • The RBI has in its past two weekly government bond auctions allotted tenders to bidders below market prices, effectively paying higher-than-normal yields.
  • Typically, the RBI sets a maximum cut-off yield for bids and employs a process known as ‘devolvement’ for weak bond tenders in which the auction’s underwriting dealers buy up the shortfall in undersubscribed tenders at the cut-off yield.
  • This is why the RBI has avoided devolvement at its Nov. 27 and 20 auctions, despite tepid appetite, and has chosen to accept all bids, even those demanding yields above the majority of the bidders.
  • The RBI’s last devolved auction took place in June when demanded yields rose to rates that were uncomfortably high for the central bank.
  • Last Friday, the RBI sold 150 billion rupees of bonds, almost half of which were 10-year benchmark bonds priced at a 7.76 percent yield, 4-5 basis points higher than market rates on that day.
  • A surprise RBI announcement on Wednesday to buy $1.5 billion of government bonds in the secondary market, however, is targeted at countering the recent rise in yields and easing tight cash conditions. The move helped push yields down six basis points on Thursday.
  • And as a result, yields at this week’s RBI bond auction on Friday are also likely to be lower.
  • However, analysts say the RBI’s current strategy comes with hazards and may perversely create more problems.

RBI intervenes as rupee slipped