Policy transmission disjointed in bond market: RBI deputy governor Patra

Certain features of the domestic market for government securities dampen the transmission of monetary policy, with uneven market liquidity being a key factor, Reserve Bank of India (RBI) Deputy Governor Michael Patra said.

“The G-sec (government security) market’s microstructure also tends to dampen transmission… the lament of monetary policy in India is that liquidity in the G-sec market is not uniform across the curve and concentrated in only on-the-run securities of five years, seven years, 10 years and 14 years maturities,” Patra said at the Treasury Heads’ Seminar organised by the RBI at Lonavla on November 12.

The RBI released the speech on its website on Tuesday.

While government securities market is the venue through which various levels of the government raise funds, from a monetary transmission perspective, its importance stems from providing a risk-free term structure for pricing instruments issued by the rest of the economy, Patra said.

“…monetary policy signals are conveyed across the curve in a disjointed manner, reflecting time-varying liquidity premia, and with diminishing intensity as maturity increases. The G-sec market is also vulnerable to spillovers from both global and domestic developments,” he said.

The deputy governor flagged instances of wild swings in sovereign bond yields in response to factors such as the announcement of the government’s borrowing programme, geopolitical developments and interest rate changes by major global central banks.

“Even shifts in international crude prices send them into a frenzy and as a result, the risk of transmission losses for domestic monetary policy rises,” he said.

On February 1, 2022, yield on the 10-year benchmark government bond had shot up 15 basis points after the Centre unveiled a larger-than-expected borrowing programme in the Budget for the current financial year. So far in 2022, the 10-year bond yield has climbed 81 basis points in response to factors, including rate hikes by the RBI, tighter liquidity conditions and uncertainty over the extent of US rate hikes.

According to Patra, the lack of meaningful trading volumes in two of the three maturities of the Treasury Bills (T-bills) that the government regularly issues calls for a rethink in their maturity profile.

Pointing out weaknesses in the transmission chain of the RBI’s interest rate actions, Patra said even before the monetary policy signal transmits through the overnight and term segments to the 91-day T-bill, some of the impulse is lost in transmission.

“In the secondary market, trading is concentrated in the 91-day T-bills, with the 182-day and 364- day T-bills being highly illiquid.

Given this discontinuity, the situation in India calls for active market making in each of them and perhaps issuances of T-bills of other maturities as well so that a continuous risk-free yield curve emerges,” he said.

The central banker said experience of several decades has been that markets are prone to idiosyncratic outcomes, overshoots and failures.

“In these circumstances, they need to be intervened to restore stable functioning and to produce competitive outcomes,” he said.

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