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RBI may need to drain Rs 1.4 lakh cr as inflows add to excess liquidity

Strong foreign investment inflows have sent the rupee up nearly 7% against the dollar

Reuters  |  Mumbai 

RBI, RBI monetary policy

The Reserve Bank of India (RBI) will likely have to drain up to $22 billion in from the financial system as surging foreign investments force the central bank to absorb the inflows and sell rupees to cap gains in the local currency.

Foreign investments into debt and shares have reached a net $31 billion this year, compared with $2.7 billion in sales last year, due to factors including India's low and improving economic growth.

The strong inflows have sent the up nearly seven per cent against the and forced the to buy more than $10 billion in the spot market and $10 billion in forwards this year - which has meant an equivalent infusion in rupees.

Those sales have added liquidity into a financial system already flush with cash after a ban on higher-denomination currency in November sparked a surge in bank deposits.

Average daily liquidity has risen to around Rs 3 lakh crore, well above the RBI's goal of around Rs 1 lakh crore, according to traders.

That will force the to step up debt sales to remove liquidity and avoid any inflationary impact.

Traders estimate the will need to drain Rs 1 lakh crore to Rs 1.4 lakh crore ($15.7 billion to $22 billion) after taking into account factors such as festival-related consumer spending that naturally reduce cash in the system.

How the drains the cash will thus become an impact factor for bond traders, who have benefited from a rally in debt markets.

"I don't think the RBI's intent is to choke the system of liquidity but also at the same time they don't want to maintain excessive liquidity in the system which could obviously create a pain point from an perspective," said Lakshmi Iyer, chief debt investment officer at Kotak Mahindra Mutual Fund.

The has already drained about Rs 1 lakh crore via one-year bills under a special market stabilisation scheme (MSS), as well as Rs 30,000 crore in longer debt through open market sales.

Traders said they hope that will continue, noting staggered sales in bills, combined with daily reverse repo operations and some long-end sales, would be easily absorbable in markets.

The most disruptive fashion would be stepping up open market sales, which tend to focus on longer-ended debt, traders said. That may send yields higher and blunt the impact of the central bank's 25 basis point rate cut in August.

The does not provide a timetable of its special debt sales for the year.

"If drains the cash largely through MSS bonds then markets won't get too much impacted," said Suyash Choudhary, head of fixed income investments at IDFC mutual fund.

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