The Reserve Bank of India (RBI) has started buying bonds through open market operations (OMOs), sensing that liquidity in the banking system dried up substantially this week owing to advance tax outflow and should be in deficit mode in the coming days.
On Wednesday, it bought bonds worth Rs 100 billion. Any such move adds durable liquidity in the system, as distinct from short-term funds banks
borrow from the central bank.
The system liquidity deficit touched Rs 1.32 trillion on Tuesday, a day before the OMO happened. The liquidity shortage is pushing up yields on short-term money market instruments, such as 91-day treasury bills.
The cut-off yields for the 91-day treasury bill came at 7.06 per cent on Wednesday, about 30 basis points higher than what it was less than a month ago (it was 6.81 per cent on August 29). The liquidity tightness should push up the short-term yields even further for the time being.
“A sharp fall in banking system liquidity amid adverse condition adds woes for short-term yields. Though the cause was largely anticipated, foreign exchange markets intervention and market sentiment might have precipitated adversities,” said Soumyajit Niyogi, associate director, India Ratings and Research.
However, Niyogi said, a rise in rates “could provide breathing space for rupee” as debt instruments become attractive for foreign investors.
According to State Bank of India group economist Soumyakanti Ghosh, the RBI
can potentially pump in at least an additional $25 billion from its reserves to support the rupee.
This intervention, if it happens, can dry up liquidity in the system beyond September.
Issuing dollar bonds to non-resident Indians can potentially solve the rupee slide but it would be a less preferred option, considering 42 per cent of India’s external debt is maturing in the short term. However, this option will likely not disturb the liquidity except when the bonds mature.
Most in the market expect the RBI
to continue with OMOs. The central bank has done four OMOs bond purchase so far, pumping in durable liquidity worth Rs 400 billion in the system.
The rise in short-term yields is happening simultaneously with the rise in longer-term yields too. The 10-year bond yields have crossed 8 per cent, as rupee nears 73 a dollar.
The interim measures announced by the government had failed to enthuse the market, as the measures were more relevant from a longer term perspective.
But the liquidity tightness is not much of a cause for concern for the banking system, as the government is expected to start spending soon. Government’s cash balance with RBI
stands at Rs 4.8 trillion.
Besides, the liquidity tightness was predicted by the RBI in advance. In June and July, the system liquidity was in neutral zone, but turned positive subsequently.
The call money rates, however, went up by abouto 10-15 basis points anticipating tightness in liquidity in September, on account of advance tax outflow.
According to CARE Ratings, the average daily borrowings in the call money market during the week ended September 7 was higher by 28 per cent at Rs 15.63 billion from the average borrowings of Rs 12.22 billion in the previous week. The spike in borrowing could be explained by the possibility of liquidity turning tight ahead of advance tax outflow.
“Though the growth in currency in circulation has moderated to some extent recently, its expansion remains above historical trend and as we have been telegraphing, reserve money growth is expected to pick up in the second half of fiscal year 2018, it is usually coincident with the start of the festive season,” RBI deputy governor Viral Acharya said in the August 1 monetary policy.
“RBI will continue to actively manage the system liquidity so as to achieve the monetary policy objective of aligning the overnight weighted average call rate with the policy rate while meeting economy’s demand for reserve money growth. The evolving liquidity conditions will determine our choice of specific instruments for transient and durable liquidity management,” Acharya had said.
Banking system liquidity tightening affects different banks
with good deposit bases, are typically lenders in the overnight money market segment, whereas, smaller banks are borrowers. Therefore, the liquidity is highly skewed in favour of larger banks. Whenever the system suffers from liquidity shortage, it is mainly the smaller banks that have to shell out higher interest rate to get liquidity support.