Yields on state govt bonds harden ahead of RBI policy announcement

The yields on state government bonds at Tuesday’s auction hardened by 8-15 basis points (bps). This comes a day ahead of a review by the Reserve Bank of India’s (RBI’s) monetary policy committee (MPC), which is widely expected to hike the policy repo rate.

According to the RBI data for the 10-year paper, the cut-off was 7.89 per cent, against about 7.81 per cent last week. Also for the 12-13-year maturity corridor, it was 8.03 per cent on Tuesday, compared with 7.87 per cent last week, according to the RBI and ICRA data. The Maharashtra government was the only state to have raised Rs 2,000 crore through the 10-year paper.

Bond dealers said the hike in yields on state government paper was in line with the increase across the board — treasury bills, Government of India (GoI) bonds, and corporate paper. This reflects the expectation of a further policy rate tightening by the RBI to battle inflation. Yields are likely to move up more sharply at the lower end of maturity than long-tenure paper.

Four states — Maharashtra, Andhra Pradesh, Telangana, and Tamil Nadu — raised Rs 12,000 crore via development bonds, with the duration of paper between eight and 14 years at Tuesday’s auction. Last week (May 31), 11 state governments raised Rs 22,500 crore through state development loans (SDLs) on May 31.

The spread between the weighted average yield on 10-year SDL and 10-year GoI paper has moved between 40 bps and 50 bps. The spread is shaped by the scale of supply. The spreads have widened in a week when more states hit the market with their borrowing plans. They tighten when fewer states come with smaller volumes.

Eight states, including Assam, Madhya Pradesh, Chhattisgarh, and Uttarakhand, which had initially indicated they would borrow during April-May (FY23), are yet to access the SDL market. Perhaps, they are still awaiting the borrowing permission from the GoI as the related guidelines have undergone change in FY23, said ICRA.

The market is expecting between 25-bp and 50-bp hike in policy repo rate at Wednesday’s MPC review. On May 4, the MPC had hiked the repo rate by 40 bps in an off-cycle policy meeting.

The central bank could take comfort from the recent measures announced by the government to combat inflation. Moreover, the expectation of a normal monsoon and some recent moderation in global food prices also provide succour to the food inflation outlook.

After delivering a 40-bps rate hike in May, the central bank could err on the side of caution and avoid any major disruptions in the financial market, said HDFC Bank’s treasury research desk in note.