On 20th March 2015 bonds worth Rs 302.28 billion maturing in 2015-16 were switched by RBI from its own account to longer maturity 2026-27 bonds with government.
The switch was part of the budgeted switch of Rs 500 billion that was scheduled for fiscal year 2014-15. Read our note on Understanding Bond Switches.
This is the first time RBI is carrying out a switch with the government from its own account. RBI has a stock of government securities worth Rs 5250 billion on its own books as it was a net buyer of bonds worth Rs 5250 billion in the 2008-09 to 2013-14 period. In fiscal year 2014-15, RBI has net sold bonds worth Rs 600 billion from its books.
What does a bond switch by the RBI with the government imply? What signal does it send to the market?
On the face of it, the switch is routine as the RBI has bonds maturing in 2015-16 and the government wants to buy back the bonds. However, the government could well have bought back the bonds from the RBI and auctioned an equivalent amount of bonds maturing in 2026-27 to the market instead of giving RBI the bonds. The market would have determined the yields on the bonds and RBI would not have to explain why it chose to do a switch with the government.
Taking the switch transaction as a seperate transaction on each leg i.e RBI selling bonds to the government and RBI buying bonds from the government. RBI selling bonds to the government would be consistent with its approach of selling bonds through OMOs in this fiscal year. RBI has bought USD 40 billion in the spot market infusing liquidity of Rs 2455 billion. RBI has been selling bonds to sterilise this liquidity infusion.RBI is managing its balance sheet by buying USD and sterilising the liquidity through bond sales from its books.
RBI buying bonds from the government is inconsistent with its approach of selling bonds to sterilise liquidity. Buying bonds is akin to money printing though in this case of switch, RBI is not really printing money as it has sold an equivalent amount of bonds to the government. The question market is asking is, why did the RBI choose to buy bonds rather than asking the government to auction bonds to the market?
Does RBI want to maintain its stock of government bonds? Or is the central bank trying to send yield signals by buying long maturity bonds at current levels of yields?
Will the RBI sell these bonds through OMO?
Too many questions for one switch. RBI has definitely sent out wrong signals to the market with this switch.