RBI monetary policy: Bond market awaits cues on liquidity support

Perception of comfortable liquidity is different for RBI and markets

Bond dealers and economists would keenly watch the Reserve Bank of India’s (RBI’s) stance on liquidity in the monetary policy statement on Thursday, as there seems to be a mismatch between what the central bank perceives as comfortable liquidity and what the market expects the liquidity to be to keep bond yields under check.

RBI’s Deputy Governor Viral Acharya is of the view that as long as call rates remain below the policy repo rate, the liquidity scene is comfortable. But this is disputed by the bond market, which expects the central bank to continue with its open market operations (OMO) support, under which it buys bonds from the secondary market to infuse liquidity.

The banking system liquidity is now comfortable and is in the positive territory. The RBI has done about Rs 2.4 trillion of OMO purchases this fiscal, and has promised to support the market as and when required. In February, the plan is to buy Rs 35,000 crore of bonds from the secondary market to support weekly borrowings of Rs 18,000 crore each.

The banking system is happy with the way the RBI has supported liquidity needs.

“As far as liquidity deficit is concerned, the RBI has taken care of it by undertaking OMO purchases from time to time, as a result of which the banking system has moved into a liquidity surplus as of February 4, 2019,” Care Ratings wrote in a report.

However, the market has a problem with the RBI’s yardstick of liquidity measurement.

“Call money market is just 1 per cent of the total bond market. That one per cent cannot be the yardstick for the system liquidity,” said a bond dealer.

According to a senior economist, the liquidity situation is comfortable now because the government is running a low cash balance with the RBI. The government is spending the money before the year comes to a close. But from the next fiscal, it will start cutting down on its expenses and cash balances will build up. Besides, advanced tax outflow in March will also run the system dry.

These were a few feedbacks that economists and market participants had given to the RBI top officials, including Governor Shaktikanta Das and Deputy Governor Acharya, to consider, rooting for more OMO support.

According to market participants, rather than such indirect measures as call money rates, bond yields should be a direct indicator.

Bond yields had risen sharply in 2018 as the RBI stubbornly refused to provide OMO support. But they had to do it eventually from September, as the 10-year bond yields crossed 8 per cent.

As on February 5, the banking system had a liquidity surplus of about Rs 16,367 crore, but on January 22, the system ran into a deficit of Rs 21,269 crore. These numbers, though, are perfectly acceptable, as up to Rs 1 trillion deficit or surplus can be handled by the banking system smoothly. Anything more than the figure strains the system, bond dealers say.

Most don’t expect a rate cut on Thursday, but expect a change in stance to neutral. However, in the medium term, the bond market needs either rate cut, or persistent liquidity support to keep the rates under check. The longer tenure yields have firmed up on persistent supply and the next fiscal’s Rs 7.1 trillion of gross borrowing will strain the market even further.

“If the RBI doesn’t support the market in the next fiscal, like what it did in the later part of this year, the bond yields will easily cross 8 per cent,” said the head of investment of a mutual fund.

Much of that support should be communicated in the February policy, instead of waiting for the next policy in the next fiscal, he said.

The most traded nine-year bond yields closed at 7.57 per cent, while the new 10-year yields closed at 7.36 per cent, down from 7.38 per cent on Tuesday.