India’s central bank added more firepower to its inflation-busting toolkit as the nation’s entry into global bond index is set to test policymakers’ resolve to manage billions of dollars of inflows that could further fan price pressures.
The Reserve Bank of India may consider selling bonds to sponge off surplus cash, Governor Shaktikanta Das said Friday, while keeping the policy rate unchanged. The surprise announcement soured the mood in the debt market, sending benchmark yields surging by the most in over a year.
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“Unexpected by all, the RBI announces that OMO sales also become a policy tool for the future in its efforts to suck out liquidity,” said Indranil Pan, chief economist at Yes Bank Ltd. “This is important even from a longer perspective, given that India could be expecting large foreign exchange flows next fiscal on the back of bond index inclusion.”
JPMorgan Chase and Co. last month said it would add India’s bonds on its emerging market gauge by June. The move could bring in as much as $50 billion from investors, with a fifth of the flows likely by March, according to ICICI Bank Ltd.
The inflows will add to the RBI’s challenge of keeping liquidity on a leash even as it may need to buy dollars to prevent a sharp appreciation in the rupee.
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The RBI has been selling dollars to defend the rupee as rising Treasury yields dampen the lure of riskier assets. It may need to fine tune its foreign-exchange strategy as the currency hovers near a record low, with traders citing continued central bank support.
The yield on 10-year notes climbed as much as 15 basis points, the most since August 2022, to 7.37%.
Das said the plan to sell bonds was part of the central bank’s liquidity management an not linked to the potential inflows from the index inclusion. The RBI doesn’t target a level for the rupee and intervenes only to check volatility, he said.
The RBI has been using its reserves pile of nearly $600 billion, making the rupee one of the least volatile currencies in emerging markets. It has slid 0.6% to 83.2450 against the dollar this year.
Liquidity Tools
“The RBI’s activities may increase even more in the currency market in the short run,” said former deputy governor R. Gandhi. “A sudden jump in inflows will push up RBI’s activities but it has enough tools to manage the volatility and inflows.”
The central bank’s dollar purchases result in rupee liquidity being injected, which adds to concerns about price pressures. While inflation moderated to 6.83% in August, the reading is well above the RBI’s tolerance limit.
“I would like to emphatically reiterate that our inflation target is 4% and not 2%-6%,” Das said Friday, adding that inflation remains a major risk.
The central bank has several tools to absorb inflows — from reverse repo operations to issue of sterilization bonds, open market operations or OMO bond sales to the more direct cash reserve ratio requirements. It can also use forward market intervention to push back liquidity injection to a future date.
“We expect RBI to resort to OMO sales to sterilize liquidity only once the foreign inflows commence in the bond market in 2024, and durable liquidity goes above the comfort zone of the RBI,” Edelweiss Mutual Fund wrote in a note to clients Friday.
--With assistance from Kartik Goyal.
Author: Subhadip Sircar, Anup Roy and Malavika Kaur Makol