RBIs debt purchases to offer temporary relief

Written by Reuters | Mumbai | Updated: Mar 31 2012, 06:13am hrs
The Reserve Bank of India's efforts to ease a prolonged cash strain through debt purchases will only offer temporary relief to bonds and swap markets, given the heavy supply of debt waiting to be sold in coming months.

RBI officials have made clear any injection will be motivated solely by liquidity shortages, especially ahead of big weekly sales of debt, and have been consistent with their message that they are not focusing on bond yields.

Analysts say the RBI will likely use OMOs as just opportunistic liquidity tools, making them unlikely as a springboard for a rally in Indian bond prices.

That makes the 13-basis points intraday drop in 10-year benchmark bond yield seen on Friday unlikely to be sustained, according to dealers, and they could soon move back towards the nearly three-month highs seen earlier this week.

Today's downward movement in bond yield is not sustainable because of heavy supply line up. The 10-year bond yield is likely to go back to 8.60-8.70 percent zone as supply hits, said Vivek Rajpal, India rate strategist, Nomura.

Yields for India's benchmark 10-year bonds have surged since the government announced higher-than-expected plans to borrow R5.7 trillion in the April-March fiscal year, of which 3.7 trillion rupees ($72.7 billion) are coming in the first half.

The RBI is worried the looming supply would exacerbate the tightness of liquidity, amply reflected in interbank funding, especially ahead of next week, when a record 180 billion rupees will have to be absorbed in two days due to holidays.

The cash rate has hovered close to 10% this week, and surged to near a three-and-a-half year high of 15 percent on Friday as banks avoided lending on the penultimate day of the fiscal year 2012/13.

Banks have been clamouring for cash, borrowing over 1.4 trillion rupees daily on an average since January from the RBI's repo window, with the amount hitting a record high of 1.96 trillion on Monday.

However, the broader liquidity shortage is expected to ease by April when government spending kicks in, meaning the RBI may only have to step in again via opportunistic injections.

While we do not expect weekly OMO purchases to resume, we do not rule out infrequent OMOs should bond yields spike up again or auctions face lackluster demand. Such episodes may still be liquidity driven, said A. Prasanna, economist, ICICI Securities Primary Dealership in a note.

The rupee is yet another factor that could dampen impact of OMOs from the RBI. The currency continues to tumble-down more than 4% this monthforcing the central bank to sell $19.86 billion worth of dollars from September to January to protect it.

Since the RBI is expected to continue with more intervention to prevent a sharp fall in rupee, i t would need far bigger action, probably through a follow-up to the combined 125 basis points in cuts in the cash reserve ratio it undertook earlier this year. If RBI intervenes in a big way even going ahead, then only OMOs may not be adequate, and a CRR cut could be required after April, said Prasanna.