Monetary transmission of a different kind

Despite a 1 percentage point rate cut, bond yields have been rising, and the spread between government securities and SDL as well as corporate papers is widening

- Tamal Bandyopadhyay

On August 26, at an auction of state government securities, called state development loans (SDLs), Maharashtra did not accept a single bid. Like many other states, it was in the market to raise ₹4,000 crore through bonds maturing in four, eight, nine and 10 years. There were plenty of bids worth at least ₹15,000 crore for its SDL, but the state didn't want to pay the bidders' asking rate.

This doesn't happen often. The last time a state didn't accept any bids at an SDL auction was on April 25, 2018. The state, again, was Maharashtra, and it had Andhra Pradesh, Odisha and Rajasthan for company. The four collectively wanted to raise ₹5,500 crore, but did not accept any bids.

In last week's SDL auction, the cut-off yield for a 10-year paper, floated by Rajasthan, was 7.49 per cent. That made the gap, known as spread in the bond market, between a 10-year government security and a comparable maturity SDL, 84 basis points, or bps. One bps is a hundredth of a percentage point.

The yields have been rising for all papers: Government securities, SDL and corporate bonds. And the spread between government security and SDL as well as corporate papers has been widening.

Media reports indicate that last week, at least two corporate entities—Housing and Urban Development Corporation Ltd (Hudco) and non-banking financial firm Bajaj Finance Ltd—dropped their plans to raise money from the public as the yields were higher than they expected.

Before we delve deep into the bond market scenario, here's a background of this phenomenon.

Retail inflation in July rose 1.55 per cent, its slowest pace in eight years, staying below the Reserve Bank of India's (RBI's) target for the fifth month in a row. The central bank follows a flexible inflation target of 4 per cent with a 2 percentage point band on either side. Since January 2019, this is the first instance of retail inflation falling below the RBI's target.