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In what can be seen as an acknowledgment of the collateral damage done by the RBI's liquidity tightening measures to check the rupee's fall, the central bank on Tuesday changed tack and announced steps to cool down the long-term cost of funds in the market.
The RBI also provided some relief to banks whose treasury portfolios were suffering heavy mark-to-market losses on account of the spike in bond yields.
The RBI will buy Rs 8,000 crore worth of long-dated government bonds through an open market operation on August 23 in order to bring down yields at the longer end. "It is important to address the risks to macroeconomic stability from external sector imbalances. At the same time, it is also important to ensure that the liquidity tightening does not harden long-term yields sharply and adversely impact the flow of credit to the productive sectors of the economy," said the RBI in a release.
"This is a proactive measure taken by the RBI and it will bring down bond yields by at least 20-25 bps at open on Wednesday. It will also have a positive spin-off on the currency," said NS Venkatesh, head of treasury at IDBI Bank.
The RBI's rupee-centric measures taken since July 15 had driven up bond yields across the curve as against the central bank's aim to increase yields only at the short-end.
These measures had driven up short-term yields by a massive 400 bps, but long-term bond yields also rose by a whopping 200 bps. The 10-year yield spiked to a 5-year high of 9.47% on Tuesday before closing at 8.90%.
On July 15, the RBI put a cap on banks borrowings from its daily repo tender, raised the Marginal Standing Facility rate to 10.25%. It subsequently announced weekly issuance of R22,000 crore worth of cash management bills.
"Yields should come down by 20-30 bps because of these measures. These are very positive and the Bank Nifty could go up, which could have a positive impact on the currency," said Jayesh Mehta, managing director and head of global markets at Bank Of America-Merrill Lynch.
The spike in yields had put