By Suvashree Choudhury and Swati Bhat
MUMBAI (Reuters) - The Reserve Bank of India (RBI) eased cash requirements for banks on Thursday and said it would provide "durable liquidity", but the relief was short-lived for markets fearful of a credit crunch arising from problems among non-banking finance companies.
The government, central bank and market regulator were first put on guard against the risk of contagion following a series of debt defaults by one of India's largest infrastructure finance companies since last month.
Confidence has ebbed in India's markets. The rupee has been plumbing all time lows, bonds are their weakest since November 2014, and share markets have suffered a sharp correction after record highs in August.
Following up on earlier attempts to calm investors, the RBI eased bank's liquidity coverage ratio norms, allowing them to include upto two percentage points more of government securities in their statutory liquidity ratio reserves.
"This...will help improve the distribution of liquidity in the financial system as a whole," the RBI said.
The announcement, along with a hike in import tariffs by the government late on Wednesday, briefly boosted sentiment towards bonds and the rupee, though investors said the steps, which only come into effect on Oct.1, were unlikely to have any immediate impact on liquidity.
But, dealers also expect the central bank will announce more open market purchases of bonds in the coming days.
"This easing does help, but in my view it doesn't affect system liquidity by much. Banks had been issuing short-term papers of 2-4 months to meet liquidity coverage ratio requirements, with this move, that pressure will go away," said the head of trading at a private bank.
The 10-year benchmark yield was trading flat on the day at 8.07 percent by 0750 GMT after earlier dropping as much as 3 basis points.
The yield is already up nearly 40 basis points since the start of August, when weakness in the rupee had been the driving factor.
Subsequent RBI intervention to support the rupee has, however, had a secondary effect of tightening domestic rupee liquidity.
Traders are now keenly awaiting the government's borrowing schedule for the second half of the financial year, due to be announced on Friday, wanting to see if the government announces reduced borrowing needs.
Indian banks currently have to buy government bonds worth about 19.5 percent of their deposits as a part of their statutory liquidity ratio (SLR).
In the currency market, the partially convertible rupee gave up earlier gains to trade weaker at 72.69 to the dollar versus its previous close of 72.63, though its fall was in line with other Asian peers reacting to a hike in U.S. interest rates.
Having lost 12 percent against the dollar, the rupee remains Asia's worst performer so far this year.
Attempting to rein in a widening current account deficit that had been one of the main factor's behind the rupee's weakness, the government on Wednesday raised import tariffs on 19 "non-essential items".
"I think the measures that have been taken, especially on the import-taxes side will not have an immediate impact on the current account," said Khoon Goh, head of Asia research for ANZ.
"Any rebounds in the rupee might prove to be short-lived," he said. "There's still very strong dollar demand and there's a shortage of dollar liquidity onshore. That will continue to put pressure on the Indian rupee."
(Additional reporting by Nikhil Kurian Nainan; Editing by Simon Cameron-Moore)
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