Market expects OMOs to resume from Oct

So far in FY14, RBI has infused Rs 30,000 cr via open market operations

With the Reserve Bank of India (RBI) assuring market participants that it will ensure adequate liquidity to support flow of credit to the productive sectors, the bond market expects RBI to conduct open market operations (OMO) for infusing liquidity in October.

“The next OMO may happen in the second week of October. From then, banks will be busy for the lending season. At that time, some liquidity support can come. After yesterday’s (Wednesday) assurance by RBI, sentiments in the bond market improved,” said N S Venkatesh, chief general manager and head of treasury, IDBI Bank and chairman of the Fixed Income Money Market and Derivatives Association of India.

So far in the current financial year, RBI has infused liquidity by about Rs 30,000 crore through OMOs.

OMO is the buying and selling of government securities in the open market by the central bank, in order to expand or contract the amount of money in the banking system

“OMOs will be based on RBI's assessment of liquidity. One has to be patient. Traditionally, RBI did more OMOs in the second half of a fiscal. The busy season and the festive season will drain cash out of the system, that is when we can perhaps expect (OMOs). The second half of October may be the time for initiation of OMOs, based on RBI”s assessment of systemic liquidity,” said Dhawal Dalal, executive vice-president and head of fixed income at DSP BlackRock Mutual Fund.

Liquidity will remain tight owing to sluggish deposit growth, while credit growth has picked up thanks to festival-related demand. The gap between deposit and credit growth has widened with credit expanding at 18.2 per cent, while deposits are growing at 13.4 per cent, on a year-on-year basis. Bond yields had hardened following RBI’s liquidity tightening steps announced on July 15. Of late, banks have been borrowing heavily from the central bank. Apart from capping borrowing from liquidity adjustment facility at 0.5 per cent of banks’ net demand and time liabilities, the marginal standing facility (MSF) rate was also raised by 200 basis points (bps) to 10.25 per cent.

In the mid-quarter review of monetary policy last week, the MSF rate was reduced by 75 bps and RBI is expected to withdraw the steps in an calibrated manner.

Currently, RBI is injecting about Rs 1.5 lakh crore into the banking system on a daily basis through the LAF, the export credit refinance facility (ECR) and the MSF taken together. The government has announced a gross borrowing programme of Rs 5.79 lakh crore for the current financial year. Out of which, the market borrowing will be Rs 2.35 lakh crore in the second half.

According to the central bank, despite the liquidity infusion, liquidity conditions have been tightening due to uncertainties around the government borrowing programme for the second half of FY14, as well as the prospective effects of banks’ half-yearly account closure, the seasonal pick-up in credit demand, festival-related demand for currency and sluggish deposit growth.

On Thursday, the yield on the 10 year government bond closed at 8.72 per cent, which has risen by about 150 bps in the current quarter. In August, yield had touched 9.23 per cent.

WHY IS LIQUIDITY TIGHT?

* Growth gap between credit and deposit growth

* Two bond auctions this week. On Monday, close one-third of Rs 15,000 crore auction devolved and another Rs 14,000 crore auction scheduled tomorrow

* Banks borrowing capped at 0.5% of NDTL

* Advance tax outflow for second quarter of about Rs 50,000 crore

* Festive season credit demand

* Only 4 OMOs conducted in H1, the last one on Aug 30