The Reserve Bank of India has accumulated so many dollars recently that it’s having a knock-on impact on the nation’s sovereign debt market.
The central bank mopped up $30 billion of dollars in the April-June period, the most in more than a decade, leading to a flood of rupees in the financial system. Data from the RBI suggest that local banks are recycling the liquidity into government bonds.
The impact from RBI’s foreign-exchange intervention explains why sovereign bonds have gained for a fifth month despite the deluge of issuances. That has also allowed the central bank to be circumspect about its own purchases to support the market, which traders have been demanding.
“The central bank’s FX policy is achieving multiple objectives of augmenting reserves, creating liquidity that’s helping demand for bonds, and at the same time curbing rupee volatility," said Naveen Singh, head of fixed-income trading at ICICI Securities Primary Dealership. “The RBI may continue with its policy of injecting funds via FX interventions over open-market debt purchases for now."
Lenders increased their holdings of sovereign debt by 13% to ₹41.5 trillion ($550 billion) as of June 5, from the end of March, according to the latest RBI data. That comes as the banking system is awashed with surplus liquidity of 5.8 trillion rupees, data compiled by Bloomberg show.
To be sure, the RBI’s 115 basis points of rate cuts this year, and other measures to ease a coronavirus-induced credit crunch, have also contributed to the funds sitting in banks.
The RBI’s forex intervention “has kept the rupee and bonds stable, and at the same time helped clear the humongous supply of bonds," said Saurabh Bhatia, head of fixed income at DSP Investment Managers Pvt. in Mumbai.
The yield on the 6.45% 2029 bonds, the most-traded benchmark debt, fell one basis point to 5.98% on Wednesday. It dropped 15 basis points in the second quarter even after the government ramped up its borrowings by 54% in May. The yield on the new benchmark 10-year debt fell two basis points.