Bonds, rupee lose big as RBI decides to stay clear

The currency and bond markets lost sharply on Tuesday in the absence of support from the Reserve Bank of India (RBI). 

Even as the Karnataka election outcome showed no clear victory for either the BJP or the Congress, market participants blamed the RBI’s inaction for the losses.

The rupee closed at 68.11 a dollar from its previous close of 67.52, and the 10-year bond yields rose for the fifth straight session to close at 7.90 per cent, from its Monday’s close of 7.83 per cent.

Year to date, the rupee is the worst-performing currency in Asia, falling 6.22 per cent. Some of its peers in Asia have strengthened against the dollar in the period. The rupee crossing the 68 a dollar-mark has also broken the trend line of technical charts, and have triggered margin calls for many banks. 

Meanwhile, the bond yields have risen about 60 basis points (bps) since the start of April and about 150 (bps) since August, when the yields had hit their lowest in recent times. When yields rise, prices of bonds fall, and investors have to revalue their portfolio with the current market price against the historical prices, resulting in nominal losses called mark-to-market (MTM) losses.

The rupee and bonds are also interlocked in the current market condition, feeding losses to each other. When the rupee depreciates, foreign investors get an exchange rate hit, prompting them to cut their exposures in bonds. Besides, rising yields also erode the value of their capital invested. As they cut their bond holding and repatriate the money, demand for the dollar goes up and the rupee depreciates more.

Even as the central bank has an official stance of ironing out volatility, if not to protect a level, the central bank on Tuesday neither intervened in the currency market, nor did it anonymously buy in the bond market, which they do sometimes when yields consistently rise.

Traders in the bond and currency markets have started questioning the wisdom of having a monetary policy committee (MPC), which has the limited mandate of guarding against inflation and keeping liquidity in the neutral zone.

“These are important mandates, but earlier, the RBI was also concerned about the markets and there was a belief that the central bank will intervene in excesses,” said an aggrieved bond dealer. 

But the RBI has intervened in the currency market in recent times. The foreign exchange reserves have come down by $8 billion in about a month as a result.
 

On May 17, it will buy up to Rs 100 billion in bonds from the secondary market under its open market operations (OMO). Macquarie expects the central bank “may need to conduct OMO purchase of close to Rs800-1000 billion in FY19, which will help to keep the liquidity condition near neutral levels.”
 

This is because the rise in yields does not help anyone. 

The rising yields are making it difficult for the corporates to borrow and is pushing up the cost of borrowing for the government as well. Foreign portfolio investors (FPIs) have also been forced to cut their India exposure, said Piyush Wadhwa, head of trading at IDFC Bank. 

The RBI has also not been clear about its stance on its policy rates trajectory.

At a time when global yields are on the rise, what has perhaps upset the market and FPIs is the communication gap. They have liquidated their bond holdings in India as a result.

"In addition to the global gloomy outlook, it is important that the MPC is consistent with its communication. The dovish tone of the policy, but hawkish tone of the minutes within a fortnight perhaps are not good impressions," said Ramkamal Samanta, vice-president-fixed income, at Star Union Dai-Ichi Life Insurance.
 

The market is not taking a firm view of the levels expected.

“It is an event-driven market. It is difficult to take a trend call in this market, as the central bank can enter anytime and the market dynamics would change,” said Jayesh Mehta, head of treasury at Bank of America Merryl Lynch. 

There are a few factors directly working against the bond market. First, the liquidity in the banking system is drying up fast. On Monday, the system liquidity was only Rs 141.52 billion in positive, numbers released on Tuesday showed. It is a significant fall from the Rs 4 trillion of excess liquidity in June 2017. The fall in liquidity pushed up the yields. 

The market has rejected buying bonds at auction for four successive weeks, whereas, banks are seeing their treasury departments booking huge MTM losses.

Crude oil prices nearing $80 a barrel is also seriously challenging the government’s fiscal math and the market expects extra borrowing later this year on account of a wider fiscal deficit than the budgeted 3.3 per cent of the gross domestic product.