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Debt Markets

Covid Pandemic Case study

In this section, we will explain what exactly has happened in the bond markets in the past 1-year, and what can we expect from the Indian Bond Markets in the near future.


Now, as soon as COVID-19 Pandemic took over the world, there was an economic crisis.


During such times, the Central Bank tries to protect people’s jobs and does everything in its power to protect the economy from entering a recession.


The first thing RBI did in India was to lower the interest rates.


Lowering of Interest rates lowers the burden for Corporates and retail, this in turn increases the amount of loans taken , which is then circulated in the economy and hence gives a push to the economy. 


If we take a look at the major economic downturns from 1992 to 2008, the methodology of lowering interest rates has been used by almost every central bank and this time also the same thing happened. 


As we all know The United States of America has the strongest economy in the world. The U.S. invests its money in the emerging markets across the globe. 


However, as soon as COVID started affecting the U.S. economy, they started using a stimulus package.


What is a stimulus Package?


A Stimulus Package is a package through which liquidity is pumped into an economy.


1.The 1st step taken up by the US was to transfer money directly into the common people’s bank account. First $900 and then $1400 was put directly into everybody's bank account. Pumping this money did not have a major impact on the broader economic activity of the country.


2.Secondly, they gave cheaper loans to corporates and industries at almost zero, which basically means that corporations now had the power to take a loan by paying negligible interest.


3.Other banking institutions, such as NBFCs had previously purchased bonds from the Government. The U.S. Government purchased back all the bonds it had given previously to those institutions. From the past few months, the US government is purchasing back almost $120 billion worth of bonds every month.


So once the cash crunch was taken care of,people had surplus money to invest. 


Since Fixed Income Securities offered low interest rates as close to 0,  alternatively people started to redirect their investments in riskier asset classes like equity.  This gave huge liquidity inflow to equity markets in the pandemic. 


Now the question arises, what makes Indian equity markets rise so much? The answer is simple, to inject money, the U.S. Government printed a lot of fresh money. The huge supply of Dollar made it weak against Indian Rupee. 


As the value of the Indian Currency was rising for the foreign investor, Foreign Institutional Investors  started investing in the Indian Equity markets because now they were getting better returns on their investments, as currency was an added advantage . 


The image below shows the yearly  money inflow and outflow of the FIIs in the Indian equity markets. 



You can visit to check FII/DII activities on daily, monthly as well as on a yearly basis. 

Gradually as vaccines were discovered , there was a hope of an economic revival. 


Once the economy revives, jobs will come back, people’s spending levels will be back to normal and this will ultimately give rise to inflation. If inflation rises, the Central banks will gradually start increasing the interest rates on bonds again. 


Important thing to note  is , neither RBI nor the Fed have increased their Repo Rates. The interest rates haven’t gone up, but the equity markets have already assumed that the interest rates will go up and that is why the YTM of different bonds have also gone up.


Another reason why the yields have gone up, because various institutions have started to sell bonds in this positive expectation scenario.


As new bonds are sold in the markets, the yields start going up and vice-versa.


When yields go up, the Longer Duration Bonds will have a bigger impact than the Shorter Duration Bonds.


Currently the US Government Bond yields have gone up by 80 bps, and the Indian Government Bond yields have gone up by 40 bps.


The reason that the US bond yields have gone up more when compared to the Indian Bond yields is because everyone’s expecting the U.S. to recover faster than India because it is a stronger country . The RBI is trying to stop the Yields from going up in India  by implying 3 methods:


1.Open Market Operations (OMO): 

OMO is a simple tool by which RBI is buying bonds it sold previously. This is creating an artificial demand for bonds. Since, the Government bonds have a duration of 10-years and those are longer duration bonds, only the longer duration bond’s yields are getting impacted. The shorter duration bond’s yields are still rising.


2.Operations Twist:

Since the shorter duration bonds aren’t getting impacted by OMOs, RBI is doing something called the Operations Twist. 


To understand this we need to take an example. The Reverse Repo Rates in India are around 3.5%, which means that RBI is taking loans from banks at a rate of 3.5%. Since, RBI is the source of printing money in India, any other company or institution in India which wants to take a loan has to pay an interest rate of more than 3.5% because the credit risk of an HDFC Bank is more than the RBI, but because there was so much money available in the markets, a company like Reliance Industries was able to borrow at a lower rate than the RBI. Reliance has issued CPs at a rate of 3% when the RBI is issuing the same CPs at 3.5%.


Due to this mismatch, RBI through a tool called Operations Twist, purchased all the 10 year bonds because of which their yields rose, but sold all the shorter duration bonds, because of which their yields fell down.


Through Operations Twist, RBI managed to neither increase nor decrease the liquidity in the markets, whereas through OMO, they were only increasing the money supply in the markets.


3.Bond Auction Cancellation:

Lastly, we saw many of the bond auctions getting canceled. For example, the Government of India wants to borrow ₹12 lakh crores. When the Government wants to borrow, several auctions take place where the Government invites institutions to bid. If the Government wants to borrow at 6.2% and the institutions started bidding at 6.5% or 7%, the Government started canceling those bids. They only accepted bids that were around 6.2%. 


Through all these efforts, the RBI is trying to control the rates, but the question is for how long can they sustain this?


The answer is not very long at all.


The main reasons for this are:


1.Growth in the economy will lead to inflation.

2.Higher oil prices will lead to inflation. 

3.RBI will try to manage the ₹/$ relationship and the only way to do that is by increasing the yields.

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