Bond mkt expects heavy RBI buying
A correction in the bond market might look imminent, considering the recent bull run and some nervousness, globally, about a possible bubble in bonds. But domestic traders are confident that domestic bonds will continue to perform well, considering the Reserve Bank of India’s (RBI) promise to keep banking sector liquidity comfortable even in stress scenarios.
To keep liquidity in a neutral zone, the central bank has to purchase huge amount of bonds from the secondary market. This will push up prices of bonds and artificially keep bond yields low. Such secondary market bond purchase is done under the central bank’s open market operation (OMO). The traders expect the central bank to start doing aggressive OMO purchases in the coming days. Estimates for the OMO vary between ~50,000 crore and ~1,50,000 crore. So far the central bank has already done OMO purchases of ~1 lakh crore.
The need for increased OMO purchase arose mainly because of a spike in currency in circulation, which grew 17.4 per cent in a year to more than ~2.6 lakh crore. A year ago, the growth was 11.6 per cent, which is normal.
The reasons for such huge cash floating in public is a matter of conjecture, as economists point out reasons like elections to festive season and even a rise in rural demand (which is largely a cash economy), but huge cash in the system is a leak from the banking system. And to plug this loophole, the central bank has to infuse more permanent liquidity by purchasing dated bonds.
Even as the banking system liquidity is in a surplus mode now, it may head back to the negative territory once the banking system starts repaying foreign currency depositors who invested in dollar bonds floated in 2013. Estimated to be costing the banking system some $20 billion in outflow, the liquidity will dry up beyond what the system can cope with.
According to various estimates, the banking system can cope with $10-15 billion equivalent of rupee liquidity, the rest have to come through portfolio inflow and RBI.
India’s current account deficit narrowed to only $300 million in the quarter ended March, on the back of a healthy portfolio inflow. Between September and November, the time when the foreign currency non-resident (FCNR) deposits will mature, an estimated $2-3 billion can be expected to flow in through the portfolio route.
In the past, the central bank had infused rupee liquidity by buying incoming dollars from the market. But this time, RBI may have to supply dollars to meet the FCNR commitments.
“The larger point, however, is that the RBI may not get too many more opportunities to engage in FX purchases on a material basis,” said JP Morgan in a recent report. “The implication is the heavy-lifting would have to be done by OMOs. Assuming there are no more FX purchases between now and March, total OMOs needed would to be another ~1.5 trillion in the next 6 months, 50 per cent higher than the first half.”
In any case, under favourable conditions, the OMO needed could be as much as ~85,000 crore, JP Morgan estimated.