The 10-year benchmark yield closed at 6.55% on Tuesday with market participants expecting yields to remain high for some time. “For the next two weeks, benchmark yields are likely to stay in the higher zone. If no further OMO sales happens, the yields may come down. If more OMOs follow, we may see the yields hardening further,” Jayesh Mehta, MD and country treasurer at Bank of America Merrill Lynch, observes. The current yields on bonds are a reflection of a cautious market that is expecting more sales of government securities via open market operations (OMOs) in the near future, bond traders said. On June 30, the Reserve Bank of India (RBI) announced the OMO sale of government securities of Rs 10,000 crore. When the markets opened on Monday, the yield on the 10-year benchmark government bonds jumped sharply by 11 basis points to 6.62% in response to the declaration. The central bank conducts OMO sales when it wants to suck excess liquidity from the system. When the liquidity is tight, the central bank conducts OMO purchases to infuse more funds into the system. The OMO sale announced on Friday is the first in the current financial year. Currently, there is abundant liquidity, so much so that the overnight call rates have consistently remained below the repo rate which currently stands at 6.25%.
Mehta points out nobody is sure whether this was a one-off or the beginning of a series of OMO sales. “There is a large amount of sustainable long-term liquidity and the central bank has said it will wait and watch to see whether remonetisation will phase out that excess sustainable liquidity. Now, how the RBI would like to do that is not very clear,” he said.
However, one can expect a series of OMO sales if the excess liquidity is not drained from the system due to remonetisation. “Even as surplus liquidity in the banking system post-demonetisation was drained by the ramping up of new currency in circulation by `1.5 lakh crore in April and May, massive spending by the government reinjected liquidity into the system, raising the daily average overall surplus liquidity to Rs 4.2 lakh crore in April and Rs 3.5 lakh crore in May,” the RBI had said in its second bi-monthly policy in June.
Some market participants believe that the fiscal may not see more than Rs 40,000 crore of OMO sales. Gopikrishnan MS, head sales and trading —Financial Markets, SA at Standard Chartered Bank, said, “I expect another Rs 30,000-40,000 crore of OMO sales this fiscal. There were expectations of OMO few months back, however the same receded after an RBI official clarified that they may not conduct OMO as they didn’t want to disrupt the government’s borrowing programme.” He added: “The announcement of OMO sale on Friday came as a surprise to the market. I believe this may not be a one-off. If they are commencing the operation, it will most likely be the first in a series.”
Gopikrishanan also said the overall liquidity in the system might be taken care of by the cash withdrawal every year. “True that the overall liquidity in the system might be over Rs 3 lakh crore. But every year, close to Rs 1-1.5 lakh crore of cash gets withdrawn from the banking system. If that trend continues, the overall excess liquidity will be taper off in two years. Hence, we are not looking at anything more than Rs 40,000 crore of OMO sales this financial year,” he said.
Meanwhile, the RBI has also revised the investment limits for foreign portfolio investors by giving more preference to long term investors.
Moreover, transfer of any unutilised limits for investment in G-secs by long term investors to the general category has been done away with. Bankers point out that this will give adequate time to major investors like insurers and pension funds to decide their asset allocation. Earlier, the unutilised limits were transferred to the general category of FPIs which were then lapped up almost immediately.
“The Reserve Bank of India has always been of the view that it wants more long term foreign investors in the market. The recent announcement stating the hike in FPI limits for long term foreign investors and stopping the transfer of unutilised limits by long term investors to the general category are clearly on those lines,” said Mehta.