Indian bond traders expect the central bank to step up bond sales for liquidity absorption, as policymakers likely seek to strengthen transmission of expected rate hikes, after the first such auction in nine years recorded strong interest.
Excess banking-system liquidity can weaken monetary-policy transmission, reducing banks’ need to borrow at the Reserve Bank of India’s policy rate, delaying increases in lending rates and supporting demand for government bonds.
Earlier in the day, the RBI absorbed cash equivalent to nearly 0.2% of total banking-system deposits, selling bonds worth 500 billion rupees ($5.21 billion) under an auction-based open market sale, its first net sale since November 2017.
The RBI sold papers maturing between fiscal 2029 and fiscal 2032 at cutoff yields that were slightly above market estimates. It is due to sell papers worth 250 billion rupees each in the next two weeks.
“The RBI will likely draw down surplus liquidity through one more tranche of OMO sales or a CRR hike ahead of the October policy review, to ensure any rate action delivers its intended transmission,” said Alok Sharma, head of treasury at ICBC.
Traders widely expect a 25-basis-point hike at the RBI’s October policy meeting.
India’s banking-system liquidity surplus hit a record 11.6 trillion rupees on September 6, boosted by one-off central bank measures to attract foreign currency, but has since eased by a third to around 7.4 trillion rupees due to tax outflows and aggressive foreign exchange intervention from the central bank.
The RBI undertook longer-duration variable-rate reverse repo auctions, but moved to a more durable form of cash withdrawal after demand fell short of expectations.
“We do not think 1 trillion rupees will be the end of the RBI’s liquidity absorption efforts. The surplus remains exceptionally large and may require several trillion rupees of draining through OMOs and other tools,” said Krishna Bhimavarapu, APAC economist at State Street Investment Management.
ICICI Securities Primary Dealership also expects the RBI to withdraw around 2 trillion rupees through bond sales, alongside the start of the rate-hike cycle in October.
