Rising retail inflation has sparked fresh trouble for the RBI. With CPI printing at 6.3%, real yields, adjusted for inflation, on India’s benchmark 10-year bonds have turned negative. It means growth in return on investments on bonds is lower than the prevailing purchasing power. Inflation corrodes the value of bonds and by default yields rise. This is the usual market-driven process. However, current 10-year yields are being ‘controlled’ at around 6% as the RBI is unwilling to sell the government paper at anything below that. Because long-term bondholders demand higher yields for carrying the risk, there are fewer buyers and the unsold gilts are bought by none other than the central bank itself. Of the Rs 1.19 lakh crore worth 10-year bonds issued so far this fiscal, the RBI ended up owning the most.
Why is the RBI adamant? Rising yields spike interest rates, which policymakers detest given the economic distress. A 1% rise in rates shoots up the government’s interest outgo by Rs 8,000 crore. In the absence of investor interest, central banks are buying their own sovereign debt, keeping bond demand and prices up. This has been the case with the US, UK, Japan and almost every other nation. But critics say investors must determine bond prices, while the yield curve should be developed by the market and not by liquidity support from central banks. Fair point. But as RBI governor Shaktikanta Das noted last year, yield curve is a public good and both market participants and the RBI have a shared responsibility.
In extraordinary times such as now, central banks deploy the sovereign yield curve as the ‘centrepiece in policy setting’. With the repo rate no longer influencing monetary policy transmission, the RBI too has unleashed the yield curve to drive a wider array of interest rates further down the floor. In fact, in Australia and the EU, yield curve control is an official policy tool. That said, it’s imperative for the RBI to ensure that its debt management function doesn’t overshadow its monetary authority, given its objective to obtain low-cost financing for the government.