Why does the RBI need to be relieved of debt management responsibilities in order to deal with bond market issues?

For 2021-22, the Narendra Modi government announced a larger-than-expected market borrowing of Rs 12 lakh crore. For the current fiscal year, the government has stated that it will borrow an additional Rs 80,000 crore from the market. The bond market appears uneasy about the additional market borrowings and the government’s announced gradual glide path of fiscal consolidation. While bond investors demand higher yields, the Reserve Bank of India (RBI), as the government’s debt manager, has been under pressure to intervene to keep yields in check.

This conflict between the RBI’s mandate to target inflation while also serving as the government’s debt manager will become more pronounced in the coming years. With a larger borrowing programme, interest rates will be under pressure to rise. As debt manager, the RBI must keep the government’s borrowing costs low. However, if inflation begins to rise, interest rates must be raised to prevent price increases. Already, the situation is deteriorating as the market puts upward pressure on interest rates.

As long as inflation remains low, the RBI will intervene and buy bonds when interest rates begin to rise, thereby increasing liquidity in the system and pushing down rates. The tug of war between bond buyers and the RBI has lasted the majority of the year. To manage yields, the central bank has used a variety of policy measures, including open market operations (OMOs) and operation twists.

To manage liquidity, OMOs typically involve the purchase or sale of bonds. When interest rates rise, the RBI purchases bonds, injecting new money or liquidity into the market. More liquidity aids in the reduction of interest rates. This year, the RBI has already purchased Rs 3 lakh crore of bonds through OMOs.

Despite these measures, demand for bonds has been muted in recent weeks. The Reserve Bank of India has refused to sell bonds at the yields demanded by bond investors. As a result, it has forced underwriters to purchase bonds. In the midst of a series of developments affecting primary dealers, the RBI has increased underwriting commissions to encourage primary dealers to buy.