Ind-Ra: RBI Pumps in Liquidity to Ease Pressure

Reserve bank of India's decision to infuse liquidity via both term repo and open market operations (OMO) route will have a salutary and sentiment impact on money market rates as well as bond yields, says India Ratings and Research (Ind-Ra). Theoretically, RBI's intention to open the OMO window to infuse rupee liquidity may be negative for the rupee. However, losses in the rupee may be contained to a large extent by exporters' USD sales and positional unwinding of the USD as we near the December 15-16 FOMC meeting.

The average daily liquidity deficit in the banking system in November has been over INR850bn and with liquidity squeeze likely in December the RBI has announced purchase of bonds. RBI announced OMO purchase of government securities worth INR100bn to be conducted on Monday along-with 28 day term repo auction for INR250bn to be conducted on Friday.

Open Market Operations are market operations conducted by RBI by sale or purchase of government securities in order to adjust the liquidity conditions in the market. RBI said these operations are being conducted based on the current assessment of prevailing and evolving liquidity conditions.

Ind-Ra has been consistently highlighting since 24th November and even emphasized in this week's DebtFx outlook, interbank system needs durable liquidity infusion by RBI in the form of OMOs. The liquidity deficit is expected to rise in the banking system further due to the December advance tax outflow and receding foreign flows, RBI needed to shore up the domestic assets to maintain reserve money growth.

Foreign institutional investors have sold equity and debt worth USD1.7bn in November and the expected further outflow of USD in the month of December, due to the close of the calendar year internationally and the expected hike in interest rates in the US may put additional pressure on the Indian currency.

Government bond yields during Oct-Nov period have stayed on the higher side, one of the reasons for which was the heavy SLR supply and the absence of commensurate demand growth. Demand supply dynamics in the bond market were weak since incremental appetite of most market participants was tepid. OMO purchase by the RBI, consequently, would address the dual objectives of (1) liquidity support (2) introduce fresh demand for G-Sec in market.

A strong dollar may dent US economy's prospects in the medium term. Thus beyond the December rate hike, interest rates in the US will only rise gradually given headwinds from consumption spending and exports. Earlier during the week we indicated that the rupee could flirt with 67/USD before appreciating towards 66.3/USD. Our expectations of rupee touching 66.30/USD still hold, though admittedly this target may be hit probably next week.

The announced OMO will be the first such injection of liquidity since close to two years. This fiscal witnessed both injection and absorption of liquidity through OMO purchase and OMO sales, which took place in July when the RBI removed INR82.7bn of excess liquidity from the system through OMO sales.

As the foreign portfolio limits get opened up in January 2016, liquidity pressure may also ease but until then liquidity is likely to remain in deficit closer to INR1trn. There is also likely to be additional pressure on the rupee as risk appetite is weak ahead of the ECB and Fed meetings.

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