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Views | RBI steps in to ease liquidity crunch

Views | RBI steps in to ease liquidity crunch
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First Published: Thu, Nov 17 2011. 01 20 PM IST

Updated: Thu, Nov 17 2011. 01 20 PM IST
The Reserve Bank of India has finally announced its first programme in this fiscal year to buy government bonds in what are known as open market operations. The central bank will thus release liquidity into the money market, a move that many traders were clamouring for.
The money market has been gasping for liquidity in recent weeks, with bank borrowing from the repo window climbing. The overall liquidity deficit has been far more than the Rs50,000 crore that RBI is comfortable with. It touched Rs1.27 trillion on 11 November. The deficit has been close to Rs1 trillion this week as well (see chart). Yields on the ten-year benchmark bonds have also climbed. Investors have stayed away from some recent auctions of government bonds because they fear that interest rates will continue to climb; these issues have devolved to primary dealers.
The money market has already been delivered one shock, when the government said that it would borrow around Rs53,000 crore extra in the current fiscal year, a sign that the fiscal arithmetic is worsening. A further increase in the bond issuance programme of the government seems unlikely right now, but market participants are on the edge because it is increasingly evident that the government will be unable to meet its budgeted deficit target. Some monetization of the deficit through open market operations seems inevitable.
The tight liquidity situation is the main reason why the Indian central bank has announced it would buy government bonds. The other major option it has is to buy dollars, a move that would prevent the rupee from falling further as well as inject liquidity into the domestic money market. However, there is not much room for policy action here. India has a very small balance of payments surplus right now; the flow of foreign capital is barely enough to cover the current account deficit. In the April-June quarter, India had a balance of payments surplus of only $5.4 billion.
The bond market continues to be nervous. The open market operations will put them at ease for now, but it is increasingly likely that liquidity management will be a major challenge in the months ahead.
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First Published: Thu, Nov 17 2011. 01 20 PM IST