Falling rupee takes bonds down

Written by fe Bureau | Mumbai | Updated: Jul 31 2013, 15:01pm hrs
Government bond yields surged nearly 20 basis points as the rupee gave up all the gains it had notched in the wake of RBI's liquidity tightening measures a fortnight ago even though the central bank, in its monetary policy on Tuesday, said that it would roll back these measures once the currency stabilises.

The 10-year benchmark 7.16%, 2023 bond yield settled at 8.26%, 13 bps higher than Mondays close of 8.13% after the rupee weakened to 60.48/$. Bond yields had eased 12 bps to 8.06% in the minutes after the policy was released.

Bond traders said that yields would now closely move as per the rupees movement especially after the RBIs statement that it would roll back its measures aimed at curbing volatility in the rupee only once the currency stabalises.

Bond yields would now move in correlation with the dollar/rupee. Given the situation, the rollback of the measures is likely to be slow, said Manish Wadhawan, head of rates at HSBC.

Yields had surged over 50 bps after the central bank had capped banks borrowings from the daily repo tender at R75,000 crore on July 15 and, then, later tweaked this cap to 0.5% of each individual banks deposits a week later. The RBI also hiked the Marginal Standing Facility rate to 10.25%.

The rupee, which had strengthened by 1.4% after the measures, weakened again and settled at 60.48/$ on Tuesday, just 1% away from the all-time low of 61.21/$ hit on July 8.

What is stability is not clear. What if rupee depreciates more, so the market is still worried about that, said Jayesh Mehta, managing director and head of treasury at Bank of America Merrill Lynch. RBI too has warned that its measures have just bought time for policymakers to respond to external sector pressures. The RBI wants the government to implement reforms faster and attract foreign capital to finance the current account deficit.

It should be emphasised that the time available now should be used with alacrity to institute structural measures to bring the CAD down to sustainable levels, the RBI said in its policy statement.The RBI has not said what they would do if the rupee weakens again. That is a real risk, said a forex dealer at a public sector bank. Bond traders now fear that the RBIs measures would stay for a longer period of time which would keep rates high.

Even short-term rates are expected to stay high, with the overnight call money rate seen around 10.25% in the coming weeks. Banks have borrowed nearly R25,000 crore from the MSF on Monday and R23,000 crore on Friday, which indicates liquidity is under pressure.