Traders in India have been on the edge ever since the central bank announced this month it may sell bonds to manage liquidity, without saying when.
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Traders in India have been on the edge ever since the central bank announced this month it may sell bonds to manage liquidity, without saying when.
They’re now looking to what the Reserve Bank of India does when a $5 billion currency swap matures on Oct. 23. If the central bank takes delivery of the dollars in exchange for rupees, it may sell debt to soak up the extra liquidity.
With bond yields climbing steadily since May, the sale of more debt is an unwelcome development for traders with Governor Shaktikanta Das’s announcement on Oct. 6 fueling a selloff. The RBI is seeking to contain inflation through liquidity-management tools instead of raising rates further, as it balances support for the economy.
“We know that the RBI wants to keep liquidity tight,” said Sakshi Gupta, principal economist at HDFC Bank Ltd. “We expect the RBI to let the swap mature and not roll over. If the resultant increase in liquidity is not netted out by tax outflows and festive demand increasing currency in circulation, there is a case to be made for the RBI to use this as an opportunity and perhaps do OMO sales.”
Still, there’s an argument to be made that the RBI doesn’t need to worry about excess liquidity.
The central bank’s dollar sales to protect the rupee and festive spending by consumers ahead of Diwali holidays in November will withdraw cash from the financial system.
Tax payments in December will also help, leading to a liquidity deficit until February, according to Abhishek Gupta, senior India economist at Bloomberg Economics. Excess cash in the banking system has dwindled to nearly zero from a three-trillion rupee ($36 billion) surplus earlier this year, according to a tracker.
The dollar-rupee forward premiums have come off this week in anticipation of the swap maturity as banks have entered into buy-sell swaps amid fears of a dollar shortage.
While the RBI may announce bond sales at the end of this month or next, it’s unlikely to do so as the financial system may have a liquidity surplus of just 158 billion rupees, said Nathan Sribalasundaram, rates strategist for Nomura Holding Inc, based on his estimate.
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