Bond markets rally as salute to Rajan's last monetary policy

RBI Governor says if the central bank sees stress in currency market, it will take a call on infusing liquidity in the foreign exchange markets

Giving a thumbs-up to the Reserve Bank decision to keep the system flush with liquidity and maintain an accommodative monetary policy stance, the yield on benchmark government paper (10-year bonds) eased by five basis points (bps) to a three-year low of 7.12 per cent.   

Bond dealers and treasury executives said this was a most positive aspect of the policy stance, to be open for reducing the policy rate further and to continue to inject money in the system to ward off the expected crunch when FCNR (B) deposits are redeemed over the next few months.

On this issues, of a dollar shortage on FCNR (B) deposit redemptions, Rajan said if the central bank saw stress in the currency market, it would take a call on infusing liquidity in the foreign exchange markets.

On Monday, the yield on benchmark bonds had closed flat at 8.17 per cent, as traders had turned cautious ahead of RBI’s Tuesday review.

ICICI Bank in a note to investors said the review was accompanied by an announcement of open market operations (OMOs) of Rs 10,000 crore on Thursday, lending positive cues to gilts. Further, the policy statement highlighted that liquidity easing measures would be front-loaded and this aided the domestic bonds further.

The yield on the 10-year benchmark bond eased by 30 bps over July in the aftermath of the British vote to leave the European Union, amid rising global growth concerns. In the near term, the 10-year yield is expected to trade in the range of 7.10-7.24 per cent by end-September.

OMOs are market operations conducted by RBI by way of sale or purchase of government securities, to adjust rupee liquidity conditions. If there is an excess liquidity, RBI sells securities to drain rupee liquidity. Similarly, when conditions are tight, RBI buys securities from the market.

RBI said the new liquidity framework announced in the April policy was being implemented. It has reduced some of the structural liquidity deficit.

However, Rajan said, the current surplus is partly because of seasonal factors and not because RBI has eliminated the structural deficit. RBI will proceed in a calibrated way towards the goal of doing so.

Liquidity eased significantly during June and July, with increased spending by the government which more than offset the reduction in market liquidity, due to the higher than usual currency demand.

The injection through purchases under OMOs of Rs 80,500 crore so far also helped in easing liquidity. This has brought the system-level ex ante (based on forecasts) liquidity deficit to close to neutrality, albeit without seasonal adjustment.

Accordingly, the average daily liquidity operation switched from a net injection of Rs 37,000 crore in June to a net absorption of Rs 14,100 crore in July and Rs 40,500 crore in August (up to this Monday), RBI said.