The RBI wants the yield curve to be flatter than it is, with long-term bond yields coming down. For that, it is willing to buy long-term bonds from the market. But bond traders see no reason for a fall in yields, given the expectations on inflation and the government’s medium term fiscal path. Add the fact that the sovereign ends up borrowing the most from the 8-12 year tenure, known as the belly of the curve, and the market wants a fair price for swallowing the supply.

Both sides have not relented. Bond traders have bid at higher yields for every consecutive bond sale auction and even for the open market operations (OMO) auction on Thursday, where the central bank was supposed to buy bonds. The RBI has responded by refusing to accept bids. Bond sale auctions in August saw devolvement, while all the bids at the OMO auction were refused. Meanwhile, the RBI has been conducting operation twists wherein it simultaneously buys and sells government bonds. Behind the twists is the effort to flatten the yield curve. But the RBI has largely failed to do so. In fact, the spread between the 1-year and the 10-year yield has only widened in the last six months.

In this RBI-market standoff, the loser has been the corporate borrower. “A key question to ask is whether the purpose of the liquidity measures and the operation twists etc. has been achieved. That purpose was to keep borrowing costs for the private sector benign," said R Sivakumar, head of fixed income at Axis Mutual Fund.

The expectations of a pause in rate cuts and renewed concerns over inflation have driven up corporate bond yields by 15-20 basis points recently. To be sure, yields are still about 100 basis points lower than they were six months ago. But the beginnings of a rise in yields does not augur well for borrowers. Making things complicated is the preference for only top-rated issuers. Also, the corporate bond market is still illiquid for many tenures.

The upshot is that the RBI’s measures have worked but not to the fullest extent. That demands more steps or a strong message that yields should be benign. The bond market needs a willing buyer of government paper and not an adversary on yields.