Bond buyback by RBI
India’s unanticipated decision to repurchase bonds suggests that the central bank is taking proactive steps to ease liquidity and could potentially transition to a neutral interest-rate stance in its June policy, as per Citigroup Inc. The Reserve Bank of India announced on Friday that it would repurchase 400 billion rupees ($4.8 billion) worth of bonds, all maturing in the current fiscal year ending March, on May 9. This announcement, signaling a departure from the RBI‘s previous strategy of maintaining tight liquidity, comes as a surprise, especially considering that cash conditions showed slight improvement in April.
It “is a clear signal that the RBI has moved away from the approach of keeping the overnight rates closer to the Marginal Standing Facility rate,” economists including Samiran Chakraborty and Baqar M Zaidi wrote in a note. “On the margin, this buttresses our view of a possible move to ‘neutral’ in June.”
In early trading on Monday, Indian bonds experienced a rally, leading to a drop in 10-year yields to their lowest point in approximately four weeks. The Marginal Standing Facility (MSF) represents a rate at which banks can access emergency funds from the central bank to address liquidity shortfalls. With the central bank easing liquidity, market observers will closely monitor any potential shift in its monetary policy stance, which currently leans towards the “withdrawal of accommodation” to control inflation.
As of May 3, the banking system showed a marginal liquidity deficit of 828 billion rupees, according to a Bloomberg Economics index. This represents an improvement from the 1.6 trillion rupee gap observed in late April. Despite April not experiencing acute liquidity tightness and overnight rates not reaching the Marginal Standing Facility (MSF) ceiling, Citi analysts suggest that the RBI may have anticipated election-related constraints on government spending tightening liquidity. The analysts note that the RBI has been proactive in announcing variable repo auctions and could have managed shorter rates without resorting to buybacks. They also point out that this indicates a higher threshold for announcing open-market operations sales, even if index inclusion flows further improve liquidity.
