RBI's Rs 3-trn bond buys this fiscal could distort market: Deutsche Bank

The Indian central bank’s purchases of bonds to inject cash into the financial system may have an unintended effect of distorting bond prices, according to Deutsche Bank AG.

The Reserve Bank of India should instead consider cutting the cash reserve ratio, a move it last resorted to six years ago, as various reserve requirements enforced by the authority so far are curbing deposit growth and transmission of rate cuts, said Srinivas Varadarajan, managing director for fixed income and currencies at the bank’s Indian unit.

“Open-market operation interventions beyond a point do have an impact on the micro structure of the government bond market,” he said in an interview. “The RBI should look at CRR in addition to OMOs as active instruments to manage durable liquidity in the system.”

The central bank has bought a record Rs 3 trillion ($43.5 billion) of government bonds so far this fiscal year to ease a cash crunch and is set to inject rupee liquidity via a dollar/rupee swap auction worth $5 billion on March 26.

The purchase of bonds through OMOs has led to steepening of the yield curve as most of the buying was concentrated at the shorter end. The introduction of the currency swap tool to inject cash has led to some speculation that the RBI may cut down on OMOs.

Varadarajan also shared his views on some other topics. Below are excerpts from the interview:

When would foreign flows to Indian debt accelerate?

• India must continue to show success in inflation targeting. Also, we need to ensure that whatever the forecast is on inflation, deviation from that is not too large. When people get that comfort, flows will start to come in
• The reluctance to allow an ascension into global benchmarks due to this issue of fiscal dominance will also get addressed over a period of time

Outside INR/USD, which other currency pairs need RBI attention?

• What the RBI needs to be mindful of is the cross CNY-INR exchange rate. Almost 60 percent of our electronic imports are from China and as the currency appreciates more imports will start to come from there
• It needs to intervene keeping in mind where the bilateral exchange rate is because of such issues

What is your outlook for local bonds and the rupee this year?

• The market is pricing in a 25-basis point rate cut in April. A 50 percent chance of another 25-basis point cut has been priced in
• If you have a stable government, given the high real interest rates, there’s a good chance that fund flows can be very robust
• The old benchmark should move in the broad range of 7.25-7.75 percent this year as you also have supply coming in
• If flows increase, the RBI should intervene and build reserves from 69.50/USD onward as you require that from an import-cover perspective. Around 74.50 should broadly be the cap right now