New Delhi: A blazing rally in India’s short-end bonds, driven by plans to attract foreign capital, may fizzle out because the central bank is expected to drain excess cash from the financial system, according to analysts.
BofA Securities and Bandhan AMC Ltd. expect the Reserve Bank of India to step up short-term cash withdrawal operations in coming months as surplus banking liquidity is seen climbing to pandemic-era levels of about 8 trillion rupees ($85 billion). DBS Bank Ltd. expects the central bank to deploy a stronger tool in August by requiring banks to keep a larger proportion of deposits with the RBI.
There isn’t “much room for short-end bonds to rally because if you account for the maturity of the RBI’s short dollar forward book and a potential cash reserve ratio hike, you won’t have that much surplus liquidity left in the system,” said Ashhish Vaidya, head of treasury at DBS, referring to sales of the US currency the RBI has committed to in coming months. Such sales reduce rupee liquidity with local banks.
Short-end bonds have been the largest beneficiaries of foreign inflows after the government cut taxes on debt for global investors on June 5. That’s helped push down yields on five-year notes by more than 30 basis points to 6.49%, surpassing the decline in longer-term yields and putting them on track for their biggest monthly fall in more than a year.
Concerns about whether the bond rally can continue come at a time when the RBI, unlike its regional peers, has kept interest rates unchanged and used other steps to support the rupee. Still, rising inflation and risks of further price pressures from a weak monsoon may prompt it to raise rates later this year. Deutsche Bank economists expect quarter-point hikes each in October and December.
The yield on five-year notes should stabilize around 6.50% as the RBI uses reverse repurchase operations to take out surplus cash, said Rajeev Pawar, head of treasury, Ujjivan Small Finance Bank, referring to liquidity-withdrawal steps that typically reverse in a few days.
The measures announced earlier this month to draw foreign capital and support the rupee include an incentive plan for overseas Indians on bank deposits as well as a program to boost foreign bond sales by state firms. The steps could attract as much as $80 billion, according to economists’ estimates. As banks swap the dollars for rupees, that adds to liquidity surplus.
While banking system cash surplus has dwindled to about 294 billion rupees as of Wednesday, from a high of 5.3 trillion rupees in April due to tax-related outflows, it may rise again toward the month-end due to state spending and the central bank’s dividend transfer to the government.
“It will be important to reduce surplus liquidity,” said Vaidya of DBS, citing rising inflation risks, as wholesale prices in May rose 9.68% from a year ago.
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(Updates liquidity number in penultimate paragraph.)
This report is auto generated from the Bloomberg news service. ThePrint holds no responsibility for its content.
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