InvestorQ : How has the Operation Twist undertaken by RBI impacted the yields on the benchmark bonds traded in India?
indhumathi Sayani made post

How has the Operation Twist undertaken by RBI impacted the yields on the benchmark bonds traded in India?

shrinidhi Rajan answered.
2 years ago

Over the last few weeks, the RBI has carried out a rather unusual manoeuvre called Operational Twist. According to the RBI, the Operation Twist involves buying 10-year government bonds and simultaneously selling those maturing in 1 year. Here is what you need to know about Operation Twist and its impact on bond markets and bond yields.

· Bond market scales had tipped sharply to one side. The yield on longer tenure government bonds had spiked in comparison to short-term government bonds. Longer dated bonds enjoy a ‘term premium’ or higher yield as investors perceive these to be riskier due to the uncertainty associated with a longer horizon. Investors demand higher yield for holding longer dated bonds.

· In reality, the bond market situation had been slightly anomalous. Due to prevailing economic conditions and uncertainty in bond markets, the yield curve had become steeper than usual. The yield spreads had widened considerably. Operation Twist was designed by the RBI to step in and smoothen the yield curve through simultaneous buying of long dated bonds and selling of short dated bonds

· It had its impact as it achieved the objective of bringing down elevated yields on long dated bonds, without tinkering with interest rates. This was an OMO approach rather than a rate adjustment approach. The bond market duly responded, with yields on the 10 year benchmark falling from 6.8% to 6.52% in less than 10 days.

· As a result, the spread between long and short tenure bonds narrowed significantly, checking the imbalance in the yield curve. With RBI taking a different approach, longer duration bond funds stand to gain a lot. Investors cannot really expect more such moves in the future considering the limitations in this exercise.

· Fund managers are not too clear if the central bank’s action appears an ad-hoc measure rather than a prolonged policy shift. The move appears to be more of a conundrum for the bond market as the central bank’s stated intention was not to manage the yield curve but to focus on inflation targeting.

· The RBRI has already conducted a total of 3 Operation Twists in a month on the lines of what the US Fed has been doing for a long time now. This is now considered as a more effective of managing and giving hints on rates rather than asking the Fed Open Market Committee to tinker with the rates.

· Fund managers are taking this opportunity to reduce exposure by selling bonds at lower yields, amidst prospects of additional borrowings and hardening of inflation. Most fund managers are maintaining relatively higher duration in most duration funds.