Surging bond yeilds delay recovery, vanish rate cut hopes

The ongoing surge in the bond yields will push back lending rate cuts and delay the fragile economic recovery, and there is a need for the Reserve Bank to cool them down, says a foreign brokerage.

"We think the challenge for the central bank is to comfort the markets with a mix of confidence-building measures, as the rising yields push back lending rate cuts and delay the recovery," American brokerage Bank of America Merill Lynch said in a note  on Friday.

The "easiest way" to cool the government securities markets will be to cancel the extra government borrowing of Rs 50,000 crore announced last month and fund the possible fiscal slippages by drawing down the government surplus cash balances with the RBI, it said.

The bond yields surges on average by 47 bps in the December quarter and had touched 7.44% in the last week of December, putting banks in a quandary, as their mark- to-market losses for the quarter is pegged at Rs 15,000 crore.

The brokerage said over the past three years, the government has been running surplus cash balances with the RBI averaging Rs 1.50  lakh crore on last March 31, which are accumulated through higher-than-budgeted small saving collections, surplus of state governments parked in intermediate T-Bills and non-competitive bids and advance tax payments in the March quarter.

The brokerage also advised the finance ministry against drawing from RBI's contingency reserves created from past profits and from the central bank's currency and gold revaluation accounts,which is a buffer against adverse foreign currecny movements.

Bond buybacks by government, where it has done Rs 30,000 crore as against a budgeted Rs 75,000 crore, can also calm the G-sec market, it said.

Open market operation by the RBI of over Rs 50,000 crore "would be the strongest signal as that would not only supply durable liquidity but also re-assure market concerns on the yield curve", the report said.