On reading the headline of the news article, it must have come to your mind, and you panicked as to why RBI is even selling the bonds. In response to this, you must have been worried about holding the bonds in the first place. Is that something that you must be concerned about?
Let’s get a clear understanding of what is happening in the market at this time.
What’s the role of RBI, and why are they doing so?
RBI acts as a banker for the government, or, as you may say, a debt manager, to issue and manage government securities for the government’s needs. If the RBI is selling bonds, it means they are selling them to financial institutions and the public. Usually, the buy and sell happen through primary auctions and other channels like retail market schemes, open market operations, etc.
The issuers during this time can buy the sovereign guaranteed securities on the stock exchanges, post office, or through the RBI’s website.
Here’s one possible reason why the RBI decides to sell the bonds:
- One of the primary reasons would be to control inflation.
- To drain the exceeding liquidity in the market.
- To support the goal of financial inclusion and the development of the government securities market.
- To manage the fiscal deficit and the scheme of government borrowing.
- To sway the yield curve and the interest rate in the market
The capital market works differently
For what reason did the RBI sell bonds this time?
Here’s the particular reason why the RBI is selling bonds this time: “to soak up the banking system’s excess funds.”. That is a measure taken to control liquidity, not the interest rates to tame the rising inflation, and the target is to keep the inflation at 4%. This has been done via OMO sales, and the selling is for smaller amounts.
But why is excess liquidity a concern? It can increase the risk to financial stability and the price of the bond. When inflation is on the edge, increasing the money supply is not as good an idea as it can cause inflation to occur.
Understanding the concept of RBI buying and selling bonds
Firstly, you need to know about the RBI’s assets and liabilities. RBI’s assets include gold, the dollar reserve, government bonds, and many other things; its liability is to print “money.”
RBI has its balance sheet, in which they don’t buy bonds directly from the government but rather makes market purchases, and it buys and sells the bonds consistently to balance its balance sheet. For it to make a purchase, it prints money to buy the bonds, and the same is true for dollars as well. In such a case, there is an excess supply of money in the market, which can cause inflation.
To cut the excess supply, it began to sell the bond and buy forex instead. That’s about the RBI operation. When we look at banks, when they have excess money, they park it with the RBI. Banks that way crunch some money in their balance sheet, which may be a temporary thing, but to make it permanent, they buy the bonds from the RBI when they sell and give excess money to the RBI. That way, the excess supply gets permanently extinguished from the bank’s balance sheet.
What Do You Mean By OBPP?
What does this have to do with the bond market?
When the sale occurs, the bond yield may temporarily go up, but as the RBI continues to sell, the bond yield will eventually come back and the liquidity in the rupee will reduce, which aids in contracting the RBI balance sheet. Buying and selling is a continuous process used as a tool to control many of the factors mentioned above in the beginning, and this time it is for draining excess supply in the market.
The wrap
Should the investors be worried about selling? Not really! However, although an increase in the bond yield makes the bond price less valuable as it decreases, one can sell the same bonds to the RBI at a premium when they buy them, and then one may reinvest in bonds that pay a higher percentage of interest.
This has nothing to panic an investor, unlike in the equity market, which works differently.
