MUMBAI: The Indian central bank’s plan to withdraw banking system liquidity for seven days has unsettled the bond and swap markets, as traders were hoping for a wider liquidity surplus after recent market volatility.
The Reserve Bank of India on Friday said it will conduct a variable rate reverse repo auction for 2 trillion Indian rupees ($21.58 billion), its first such operation in four months.
The banking system’s liquidity surplus rose to a near four-year high of around 4.5 trillion Indian rupees, or about 1.8% of banks’ deposits on Thursday, pushing the weighted average call rate (WACR) well below the policy repo rate.
In reaction to the announcement, bond yields rose 3-5 basis points, with the benchmark yield briefly touching the 7% mark, while overnight index swap rates rose 7-10 bps from the day’s low.
Overnight rates hovered about 17 bps below the repo rate, prompting the RBI to announce a VRRR. The benchmark bond yield touched 7% as this announcement did not go well with the market after RBI’s remarks just two days ago, said Mataprasad Pandey, vice president at financial advisory firm Arete Capital.
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“This shows a clear intent to actively absorb surplus liquidity and re-anchor short-term rates closer to the policy rate,” said Kanika Pasricha, chief economic adviser at Union Bank of India.
The choice of a 7-day, rather than overnight absorption, suggests that the RBI views the surplus as more durable than transient, she said.
On Wednesday, the RBI had kept interest rates on hold and said it would continue to ensure sufficient liquidity in the banking system to meet the productive requirements of the economy.
In the monetary policy report, also released on the policy day, the RBI signaled liquidity levels of 0.6% to 1.1% of deposits are desirable to maintain the WACR at a spread of 5-10 basis points below the policy rate.
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