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Well everyone is grappling with that question and to be honest no one has a clear idea what lies in store for Indian bond market.

What makes the scene on Indian bond market so hazy is the “lack of direction” perceived by the market on Government’s behalf. The market is in unison on the fact that yields would harden from here ( hence prices would drop as yields and prices are negatively co-related) but its trajectory has divided the market players.

With cut-offs coming at 7.30% for 6.90% GOI 2019 way above than the expected levels, it seems RBI is slowly running out of options. With the backdrop of such huge borrowing requirements of Government (Gross figure stands at 4.51 Lacs Crores for fiscal year 2009-10), RBI could not have cancelled this week’s auction on fear of high yields as it did the week before. And in a way, it was the right thing to do on RBI’s part as it reflected the market sentiments and did not make an ostrich out of it.

RBI has announced auction of 3 dated securities for 12000 Crores on 28 August, 2009. Securities on sale are 1) 7.02% GOI 2016 (6000 Crores) 2) 7.94% GOI 2021 (4000 Crores) and 3) 8.28% GOI 2032 (2000 Crores). This is in addition to the announcement of State Development Loans (SDL) auction by 5 states aggregating Rs. 4500 Crores.

Even though currently there is ample liquidity in the system (indicated by LAF window where on a daily average more than 1 Lac Crore is parked with RBI), with such excess supply of Govt. bonds, yields are bound to harden. Since the govt. has front loaded the borrowings, it leaves more room to increase the borrowings in the latter half of the fiscal if need arises. Drought situation has made matters worse by sparking the speculation that Govt. may look at its borrowing programme once again. Also no clear policy on disinvestment makes for another argument in favor of bad times to come.

So what can RBI or for that matter Govt. do? Well truely speaking Govt. realy does not have much on its hands to offer so it would not be judicious enough to expect anything from it. The only thing one can do is to pray that it does not increase its borrowings. Talking about RBI, it can give a push to OMO (Open Market Operations) or make policy changes. OMO may look to be the panacea to all ailments but would RBI inflate its balance sheet to such an extent?? I have my serious reservations. Besides would market participants be willing to sell the securities (since most of them are sitting on losses)??

Given the context of the current scenario, many dealers have started speculating that RBI may actually increase SLR from current 24% to 25% in due time. This couple with the hope that economic activity would pick up around October builds the foundation of the argument in support of yields not touching the skies.

Well only the time (or RBI as some say) will tell - what lies ahead for Indian bond market!!!