RBI starts OMOs to stem shortage in liquidity
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 ~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 ~1.32 trillion on Tuesday, a day before the OMOs happened. The liquidity shortage is pushing up yields on short-term money market instruments, such as the 91-day treasury bill.
The cut-off yield 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.
The advance tax outflow happened till the 15th of this month, and GST payments fall due on 20th.
“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, according to Niyogi, a rise in rates “could provide breathing space for the 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. Whenever the RBI pumps in dollars into the market, it takes out an equivalent amount in rupees.
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 so far, pumping in durable liquidity worth ~400 billion in the system. The rise in short-term yields is happening simultaneously with the rise in longer-term yields too. The 10year bond yields have crossed 8 per cent, as the rupee nears 73 a dollar.
The interim measures announced by the government have failed to enthuse the market as the measures are more relevant from a longer-term perspective.
But the liquidity tightness is not much of a cause for concern for the banking system because the government is expected to start spending soon. The government’s cash balance with the RBI stands at ~4.8 trillion.
The RBI had predicted the liquidity tightness. In June and July, the system liquidity was in the neutral zone, but turned positive subsequently. The call money rates, however, went up by 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 were higher by 28 per cent at ~15.63 billion from the average borrowings of ~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, which has started.
“Though growth in the currency in circulation has moderated to some extent, its expansion remains above historical trends and as we have been telegraphing, reserve money growth is expected to pick up in the second half of the fiscal year, it is coincident with the start of the festive season,” RBI Deputy Governor Viral Acharya said in the August 1 monetary policy.
“The 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 the 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.