Stressed bond dealers get RBI help

Central bank moves to infuse liquidity into bond market to help boost sentiment.

The Reserve Bank of India has moved to address pressure points in both the currency and bond markets.

The central bank’s foreign exchange reserves dipped by $3.22 billion in the week to 27 April, after having fallen by $2.5 billion in the week before, according to the RBI data.

This is the sharpest fall in forex reserves since the week ended October 7, 2016, when the reserves had dipped by $4.3 billion. Most of the dip is to check the rupee’s rapid slide, currency dealers say.

The central bank has also tried to soothe the frayed nerves of bond dealers by announcing a secondary market bond purchase of Rs 100 billion.

This, coupled with the recent measures taken to allow foreign investors to pick up any security they want without any maturity restriction, should help boost bond market sentiment by adding liquidity.

This is also an indication that the central bank will be there to help cool off yields in the future too, and should help boost the sentiment.

The rupee closed at 66.87 a dollar, while the 10-year bond yield closed at 7.73 per cent, more than one percentage point increase in about six months. The 10-year bond yield has moved up sharply after the minutes of the recent RBI’s Monetary Policy Committee’s meeting displayed a much more hawkish tone than what the April policy had stated. 

RBI Deputy Governor Viral Acharya suggested withdrawal of monetary accommodation starting June, which would mean that rate hikes could be imminent. This, coupled with continued outflow by foreign investors, pushed up bond yields.

Banks, fearing rising mark-to-market losses, have stayed out of the market in large measures. In April alone, foreign investors have taken out $121.17 billion from the local debt market.

Rising crude oil prices, the twin deficits of the country and rising yields in developed countries are also exerting pressure on local yields. On Friday, primary dealers, or underwriters of government bond auctions, had to buy Rs 17.45 billion of a bond maturing in two years, against the Rs 20 billion on offer.

In this context, what has made matters even more complicated is the lack of adequate liquidity in the market.

From Rs 4 trillion in June 2017, core liquidity in the banking system has now fallen to about Rs 400 billion. Therefore, the open market operation purchase announcement by the RBI, which will add liquidity in the system, is a huge relief for the system.

“The policy to announce the OMO will reverse the asymmetric liquidity management of the RBI and will help bring down the elevated yields in the bond market,” said Soumyakanti Ghosh, group chief economist of State Bank of India.

“Coupled with the encouraging trend in the GST collection in March, the OMO will help soothe the frayed nerves in the bond market,” Ghosh said.

According to Aditi Nayar, principal economist at ICRA, the bond yields will be contingent on whether the OMO is one-off or more will be in the offing. It is unclear as of now if there will be more OMOs, she said.

“While systemic liquidity remains in surplus as of now, it is likely to move into a deficit in the second fortnight of June 2018, around the advance tax and GST outflow dates.

“It is likely that the announcement of the OMO purchase of Rs 100 billion is a preemptive move given the expected shift of systemic liquidity into a deficit toward the end of this quarter," said Nayar. 

Soumyajit Niyogi, associate director of India Ratings and Research, however, said whether the RBI would be doing more OMOs or not would depend upon the foreign flow. 

If the flows pick up, the RBI won't need to do OMO, and the reserves would also likely get a boost, or at least, would not deplete fast, he said. More OMOs could come if foreigners continue to take out money from India.

"In a way, weak FPI flows, rising trade deficit and growing cash in circulation have proved to be blessings in disguise for the bond market," Niyogi said.

Photograph: Reuters.