RBI intent to check yields, bat for stronger rupee sparks bond market rally

Rupee closes at 72.87 a dollar, up 1.03% from previous close of 73.62. The 10-year bond yields shed 18 bps to close at 5.942 per cent from previous close of 6.117 per cent

The Reserve Bank of India’s (RBI) resolve to keep bond yields under check and the loud signal emitted in favour of a stronger rupee swiftly translated into rallies in the bond and currency markets on Tuesday.

The rupee closed at 72.87 a dollar, up 1.03 per cent from its previous close of 73.62. The 10-year bond yields fell 18 basis points to close at 5.942 per cent from its previous close of 6.117 per cent. 

While announcing the bond market related measures on Monday post market hours, the central bank had observed that the “recent appreciation of the rupee is working towards containing imported inflationary pressures.” The central bank in the past few sessions had stopped buying dollars and let the rupee appreciate in sync with the daily deluge of capital flows. 

The statement made the central bank’s intent clear. In the absence of meaningful export growth in a contracting global economy, the RBI was more willing to curb imported inflation through stronger rupee. 

On a larger theme though, rupee is still relatively weaker than its peers, even as the dollar index is at a year’s low. “The rupee movement was overdue. When the dollar depreciated, we didn’t appreciate as much as other currencies because the RBI was buying the dollars and building up its reserves. We are not done with the dollar buying yet, but there is a month’s respite," said the head of treasury of a foreign bank.   

Hence, there is a possibility that the rupee could slowly recede back to its old levels as the central bank starts accumulating reserves. But most rupee analysts, such as Satyajit Kanjilal, managing director of Forexserve, expects the rupee to reach 68 a dollar by June next year, even as in the short term, RBI may resume buying dollars and let rupee remain a little weaker.

The more sustained impact though, would be evident in the bond market. RBI not only has to manage at least Rs 12 trillion of borrowing for the centre, it has to facilitate huge borrowing by states too, pegged nearly at Rs 10 trillion for the fiscal. All these have to be done at fairly cheaper yields, maybe at around 6 per cent for the benchmark 10-year yields, as RBI has repeatedly swung into action around these levels. 

The RBI measures came after the market closure on Monday. On Friday, the central bank had refused to sell nearly Rs 18,000 crore of bonds at the rate markets were demanding, indicating it was not happy with the market ask.

The central bank on Monday increased limits on the held to maturity (HTM) category for banks, freeing up additional space for nearly Rs 3.56 trillion of bond purchase by banks. It also announced Rs 20,000 crore of special buy-sell secondary markets bond operation, and gave more liquidity in the hands of banks.   

The measures brought in by the RBI were more than what the bond market had expected, bond dealers said. If the central bank had announced the measures earlier, the yields would not have moved from 5.77 per cent to 6.20 per cent in less than a month.  

“It was a bazooka from RBI," said Jayesh Mehta, head of treasury at Bank of America Merrill Lynch.  

“The market in the past had trusted RBI’s verbal intervention and let the government borrow about half of its needs at 6 per cent or less. But the patience was waning, and bond dealers were testing the water by asking more yields. With the recent actions, the market has absolutely no doubt that the RBI stands firmly on its commitment," Mehta said. 

This also reinforces the fact that soft rates will continue and the central bank will not hesitate to introduce measures whenever rates start crawling up.  

“RBI's strong signaling through primary auction devolvement at a lower yield has been supplemented with a series of measures including additional amount of Operation Twist and HTM hike. These measures are likely to address the problem of demand supply disequilibrium to soften the interest rate," said Ram Kamal Samanta, vice president-Investment at Star Union Dai-ichi Life Insurance.