Financial markets rise on liquidity plan, shake off row between RBI, government

By Suvashree Choudhury

MUMBAI (Reuters) - India's financial markets rose on Monday, shrugging off concerns about a growing spat between the central bank and the government and preferring to take solace from plans for a big liquidity injection by the bank.

On Friday night, Reserve Bank of India (RBI) Deputy Governor Viral Acharya warned that undermining a central bank's independence could be "potentially catastrophic", in an indication that it is pushing back hard against government pressure to relax its policies and reduce its powers ahead of a general election due by next May.

But India's bonds, rupee and stock markets all gained on Monday as they took their lead from the RBI's announcement, slightly before Acharya's speech, that it will buy 400 billion rupees ($5.45 billion) of government bonds via open-market operations in November as it seeks to inject liquidity into the market.

The injection comes amid worries about a credit crunch after defaults at a major infrastructure financing company.

The 10-year benchmark bond yield fell to 7.80 percent, its lowest since Aug. 14 and compared with 7.88 percent on Friday.

The rupee rose as much as 73.32 to the dollar compared to Friday's close of 73.46, while the benchmark stock index was up 0.8 percent.

In the speech to top industrialists, Acharya cited the Argentine government's meddling in its central bank's affairs in 2010 as an example of what can go wrong. That led to an investor revolt and a surge in bond yields, badly hurting its economy.

"Governments that do not respect central bank independence will sooner or later incur the wrath of financial markets, ignite economic fire, and come to rue the day they undermined an important regulatory institution," he said.

The speech was a counter to government efforts to relax policies and curtail some powers of the central bank, further opening a rift between the RBI and Prime Minister Narendra Modi's government.

While government officials have remained largely silent in response to the speech, the issues raised by the RBI top brass -- including the government asking for higher profits from the central bank to fund its fiscal deficit -- have been well-known for years.

Traders said the markets' reaction didn't mean that they weren't watching the government-central bank relationship closely and warily.

"While the points laid down by RBI are not new, as an investor it is important to see whether the government resorts to funding its fiscal deficit by forcing the central bank to transfer more money from its reserves or not," said a foreign bank trader, adding that such "short-cuts" could hit investor sentiment.

Others were hopeful that the row would be resolved.

"If people start questioning Modi on the transparency and independence of the central bank, he might ask his officials to come to a mutual agreement with the RBI," said Ashish Vaidya, managing director and head of trading, money markets at DBS Bank in India. He said eventually a "middle ground will be arrived".

($1 = 73.35 Indian rupees)

(Editing by Martin Howell & Kim Coghill)