* Volumes drop sharply as state banks stay on sidelines
* Traders eye open mkt bond buys by RBI for assurance
* Higher bond yields push up overall interest rates in banks
By Suvashree Choudhury
MUMBAI, April 23 (Reuters) - India’s bond market has plenty of reasons to cheer if recent policy developments are anything to go by, but market participants say mixed messages from the central bank have left investors nervous and confused, adding to market volatility.
The Reserve Bank of India had in early April softened its hawkish tone, relaxed accounting rules around bond losses and raised the foreign debt investment limit, factors that should all be supportive for the sovereign debt market.
But while government bonds rallied briefly on these developments, a lack of direct RBI intervention in open market operations has left state banks - the largest group of sovereign bond investors - confused and cautious about just where the central bank’s tolerance for bond market volatility lies.
This in turn has added to market volatility and pushed yields sharply higher, impacting not only the government’s borrowing costs, but also interest rates in the overall economy at a time the Indian economy is just beginning to rebound.
“The lack of demand from public sector banks is clearly reducing trading risk appetite,” said Anindya Das Gupta, managing director and head of trading at Barclays India. “If this continues then that will create more volatility.”
In an example of the sharp swings, the 10-year benchmark bond yield hit its highest in two months on Friday after minutes of the RBI’s April 5 meeting showed a more hawkish posture than that communicated through the policy statement on the meeting day, when the bank cut its inflation projection.
Many traders say the RBI’s reluctance to address markets outside of bi-monthly monetary policy announcements makes it difficult to read the bank’s thinking. And the few occasions central bankers have spoken in such settings have only added to investor confusion, they add.
For example, bonds sold off sharply in mid-January after RBI Deputy Governor Viral Acharya warned state banks against excessively piling up on government debt. In the comments, made to a meeting of bond traders, he also indicated there would be no relaxation for banks on how they account for trading losses.
A subsequent easing of bond accounting rules announced on April 2, which allows banks to spread their losses, surprised investors and sent yields to a four-month low.
The RBI did not have an immediate comment on Reuters’ queries for this story.
“There is no reason for the madness in yields,” said a chief dealer at a large state-run bank, who did not want to be named. “But no public sector bank is confident of taking a bet on bonds.”
Sovereign bond yields have risen 130 basis points since July - the steepest rise since the currency crisis sell-off during June to December 2013.
The yield spike in 2017 was due to inflationary fears. While those factors have eased in 2018, market anxiety hasn’t.
The 10-year benchmark bond volatility index has been around 8.35 since January, compared with 7.63 from July to December, according to Thomson Reuters data. The daily average volume of bonds traded also fell to around 300 billion rupees in 2018 from 500 billion rupees during July-December 2017.
Consequently, banks have also raised their lending rates by as much as 20 basis points, which could delay a revival of credit growth key to a sustainable investment recovery.
Even foreign investors, who have been bullish on Indian debt, are turning wary.
Barclays’ Das Gupta said while foreign investors are happy with a new increased investment limit, they don’t want to increase their positions until volatility and uncertainty settles. (Additional reporting by Abhirup Roy; Editing by Sam Holmes)