Rationale And Market Impact
The decision to use a new liquidity management tool comes at the end of a financial year in which the RBI has bought large amounts of government bonds via open market operations. The central bank has bought close to Rs 2.8 lakh crore in government bonds to infuse liquidity.
The RBI has absorbed close to 74 percent of net issuance by the government through OMOs, said Anant Narayan, associate professor at SP Jain Institute of Management and Research. By announcing Buy/Sell swaps for a specific amount, the RBI will add another tool to infuse liquidity, he said.
Narayan said the announcement will be seen as negative by the bond market as the probability of further OMO bond purchases will reduce. In the currency market, the difference between the spot rate and the forward rate may narrow, making it cheaper for importers and foreign currency borrowers to hedge.
“The action (of buying foreign exchange to infuse rupee liquidity) is common but the announcement process is uncommon. The announcement effect will ensure orderly movement in forex market given some large inflows of dollars are expected. It will also domestic liquidity market by the tune of around Rs 35000 crore,” said Soumyajit Niyogi, associate director at India Ratings and Research.
While the current liquidity shortfall stands at about Rs 48,000 crore, the deficit is likely to spike to over Rs 2 lakh crore at the end of the month due to tax outflows. The RBI’s announcement may be aimed at attempting to manage the liquidity situation with a mix of instruments.
“Most importantly, the huge liquidity infusion that the RBI would have to do post the advance tax and GST payout at the end of the month would have faced a challenge in terms of availability of government bonds with banks,” he added.
Banks use government bonds as collateral to borrow from RBI’s repo window but they also have to maintain a minimum government bond holding with themselves.
“Amid current low excess SLR (statutory liquidity ratio) holding of the banks after adjusting for LCR (liquidity coverage ratio) requirement, there may not be much space for RBI to conduct longer tenor term repos/OMOs of higher quantum,” said Madhavi Arora, economist at Edelweiss Securities.