The Reserve Bank of India (RBI) on Tuesday announced a massive bond buyback programme for the current fiscal year to address the liquidity deficit — a move that’s expected to raise bond prices and boost bank treasury profits when lenders need capital.
The announcement came after the markets closed.
In a notification on its website, the central bank said it would be injecting Rs 500 billion of liquidity in December through its open market operations (OMO), in which it buys bonds from the secondary market, against Rs 400 billion planned earlier.
This will be done by increasing the remaining two OMO auctions to Rs 150 billion each against Rs 100 billion planned.
In addition, it would buy another Rs 500 billion of bonds in January through five auctions of Rs 100 billion each. The central bank said it would “consider a similar quantum of OMO purchases until the end of March 2019”.
The liquidity deficit in the banking system as of Tuesday was about Rs 1.32 trillion, partly strained by advanced tax outflows by the corporate sector. An OMO purchase infuses “durable” or permanent liquidity in the system. Unless a reverse OMO sale is done, this liquidity continues to stay and aid the bond market.
The OMO purchase in the present fiscal year will be around Rs 2.5 trillion. The central bank so far has purchased about Rs 1.57 trillion in bonds, and the latest announcement means it would purchase another Rs 800 billion at least.
“Close to Rs 2.5 trillion OMO in a fiscal year and the announcement effect of explicit guidance more in future will act as market-clearing measures. It is likely that the behaviour of current yield swill majorly be guided by OMOs,” said Soumyajit Niyogi, associate director of India Ratings and Research.
This expansion of the balance sheet by the central bank is a massive boost to the liquidity situation, and will end the December quarter on a happy note for bank treasuries. The yields on bonds are falling following crashes in oil prices, and such liquidity enhancement measures would make the yields fall even further. As yields fall, prices of bonds rise.
The yield on the 10-year bond fell 12 basis points to close at 7.35 per cent on Tuesday, an eight-month low. Bond dealers say the yield could fall by another 10 basis points soon, and can reach 7.10 per cent in January.
RBI Deputy Governor Viral Acharya promised the liquidity boost in the December policy, but this much was perhaps not expected by the markets.
"We expect this increased frequency and quantum of OMO purchases may be required until the end of March, but the calibration will depend on sustained changes in the behaviour of currency in circulation and the magnitude of sterilisation for RBI's forex operation, which keeps evolving with external sector conditions," Acharya had told reporters in the post policy conference on December 6.
The RBI’s statement repeated the deputy governor’s view.
The OMO boost will help the government in its borrowing plan. The second half is challenging because the government planned to borrow 67 per cent of Rs 6 trillion during the period. Traditionally, the government borrows the most in the first half.
However, there is a small technical challenge for the bond market in 2019 from the foreign shores.
“After the OMO purchase, the yield curve will react in consonance with global and domestic factors, and 2019 could potentially exhibit a shrinking of large central banks’ balance sheets for the first time in this decade,” said Niyogi.
Large central banks — the US Federal Reserve, European Central Bank, Bank of England and Bank of Japan — have announced they would shrink their balance sheets in 2019. If that happens, then liquidity in the international market will start shrinking.
The shortage of global liquidity will impact Indian asset classes, including bonds, and overseas yields may prompt local yields to rise.
Perhaps the central bank’s liquidity operation is aimed at addressing much of that stress in advance, said bond dealers
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