Uncertainty in Indian bond Markets

What is the issue?

RBI is taking steps to keep inflation in control but it is not potential to address the threats in Indian bond market.

What is a Bond market?

• The bond market is a financial market in which the participants are provided with the issuance and trading of debt securities.
• It is also called the debt market or credit market.
• The bond market primarily includes government-issued securities and corporate debt securities.
• It facilitates the transfer of capital from savers to the issuers or organizations requiring capital for government projects, business expansions and ongoing operations.
• In the bond market, participants can issue new debt in the market called the primary market or trade debt securities in the market called the secondary market.

How inflation controls the bond market?

• An Investor gains interest from the bond market either from the interest that bonds pay, or from any increase in the bond’s price.
• The twin factors that affect a bond’s price are inflation and changing interest rates.
• A rise in either interest rates or the inflation rate will tend to cause bond prices to drop.
• Inflation and interest rates behave similarly to bond yields, moving in the opposite direction from bond prices.
• If inflation rises bond prices tends to drop, this is due to rising prices reduce the purchasing power of each interest payment a bond makes and vice versa.

What is the role of RBI in addressing inflation?

• Reserve Bank of India (RBI) could cut rates to lift growth, but that would fan inflation even further.
• The problem gets accentuated when the RBI has an explicit mandate to contain inflation within a particular range.
• This means as long as inflation ranges between 2 per cent and 6 per cent, the central bank’s inflation targeting is working.
• If, however, prices rise or fall beyond the range for three consecutive readings, the concerns raises.

What are the threats to Indian bond market?

• After demonetisation, there is an incessant supply of state government bonds has added to the uncertainty in the bond market.
• Due to the increasing limitations foreign investors are also disinterested in Indian bond markets and can’t participate in the auctions in the stock markets.
• Banks are losing appetite for the papers as the rise in bond yields since the end of June is brining steep mark-to-market losses.
• Cues from global markets are also not very encouraging as the US continues with its rate hikes. Click here to know more about US fed rate hikes

What are the concerns with RBI’s recent moves?

• The RBI has kept its monetary policy stance “neutral” for a long time.
• But bond yields have surged 70 basis points, suggesting that the debt market is not comfortable with the situation.
• There are no indications coming from the central bank on its course of action except that it would be strictly data-dependent.
• But the market scenarios expect on a rate hike eventually pushing up yields.

Source: Business Standard