Mumbai: The RBI’s decision to pay the government a dividend of Rs 2.1 lakh crore – which will inject substantial liquidity into the banking system – led to a smart rally in the bond market on Wednesday. As a result, the benchmark 10-year paper yield fell below the psychologically important 7% mark after about a year. At market close, the 10-year bonds maturing in 2034 closed with a yield of 6.99% while those maturing in 2033 (the outgoing benchmark 10-year bonds) closed at 7.04 %. Yields on both bonds fell by 6 basis points (100 basis points = 1 percentage point), according to RBI data. Bond traders, however, said that for a further rally in sovereign bonds, they would want to know how and where the government would use the huge central bank payment. In case the government reduces its total borrowings from the market for the current financial year, it could lead to a rise in government securities. Currently, the banking system is facing a deficit of Rs 1-lakh-crore, which is keeping returns high. After the election, if the government starts spending, it will inject liquidity into the system, which could help soften returns in the market, a bond trader said. A further rise in bonds could also begin if the BJP-led government returns to power with a comfortable majority. Any unusual election results could lead to a sell-off in the bond market, the broker said. Some market players believe that the government should continue to reduce its short-term borrowings (which are bonds of less than 5 years). Such a policy could ease rates at the shorter end of the curve. And since companies mostly borrow from the shorter end of the yield curve, a lower rate could also help companies by reducing their interest expenses.
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