 "Bond mkt expects heavy RBI buying")
Even as it may look that a correction in bond market is imminent, considering the recent bull run and some nervousness globally about a possible bubble in bonds, the domestic traders are confident that the domestic bonds will continue to perform well considering Reserve Bank of India's (RBI) promise to keep banking sector liquidity comfortable even in stress scenarios.
To keep the liquidity in a neutral zone, the central bank of the country has to purchase huge amount of bonds from the secondary market and that 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) and the traders expect the central bank to start doing aggressive OMO purchases in the coming days. Estimates for the OMO vary between Rs 50,000 crore to Rs 1,50,000 crore.
So far the central bank has already done OMO purchase of Rs 1 lakh crore.
The need for increased OMO purchase has arisen mainly because of the spike in currency in circulation, which grew 17.4 per cent in a year to more than Rs 2.6 lakh crore. A year ago, the growth was at 11.6 per cent, which is normal.
Reasons for why such huge cash is floating in public is a matter of conjecture, as economists point out reasons like elections to festive season and even rise in rural demand (which is largely a cash economy), but the 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 in the system 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 their foreign currency depositors who invested in dollar bonds floated by the banks 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.
More From This Section
According to various estimates, 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 has infused rupee liquidity by buying the incoming dollars from the market but this time, RBI itself 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. 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 Rupees in the next 6 months, 50% higher than the first half," said JP Morgan in a recent report.
In any case, under favourable conditions, the OMO needed could be as much as Rs 85,000 crore, JP Morgan estimated.
According to Ram Kamal Samanta, vice president, treasury at SBI DFHI another at least Rs 50-60,000 crore of OMOs can be expected in the current cycle if equity flows remain healthy.
The current 10-year bond yield, which closed at 7 per cent on Monday, "has discounted 25 basis points cut. If in October policy there is a cut and with that OMO continues, the bond yields can drop sharply," said Samanta.