India’s central bank’s active defence of the rupee in forex markets is stalling domestic liquidity leading to investor interest in government debt, say analysts. The RBI has been intervening to buoy the rupee in the face of global currency volatility, but this is impacting liquidity and creating demand for fixed income.
To avoid rupee going into a free fall, the RBI has already sold hefty volumes of its forex kitty. This action impinges on local liquidity as it usually involves selling of dollars that are repatriated from circulation. As liquidity dries up, banks and investors have some that little cash with which to play around, so they want safer places to put it�and those would be sovereign bonds.
The exodus of liquidity has resulted in new bets by foreign and domestic investors on bond purchases, with a view that yields on government bonds could stabilize or even decline, given the central bank’s actions.
Impact on Bond Market and Yields
ADROIT BOND BUYING More fallout from the virus: If you are lucky enough to be bringing in a paycheck, now may finally be an opportune time to do some mortgage refinancing or rebalancing your portfolio if you have Treasuries that need holding during the crisis. Increased bond buying activity usually makes prices go up and yields go down. So, market participants believe RBI’s liquidity management and intervention measures will moderate bond yields ensuring government can borrow at near stable long-term rates.
This backdrop has led foreign portfolio investors (FPIs) to Indian bonds as they consider India, as compared with other emerging markets, an attractive market for fixed income investments.
Macroeconomic Implications and Monetary Policy Balance
The RBI has a tough balancing act — it wants to retain currency stability while maintaining adequate liquidity in the system for credit expansion and economic growth. Rupee’s defense must to check imported inflation and financial stability, but over-tightening of liquidity will hurt credit to industry and retail.
They have suggested continued vigilance, with policy responses being calibrated so that both exchange rate objectives and growth-supporting levels of liquidity are achieved.
Outlook
Policymakers have brought in new rules and more auctions of sovereign debt, leading investors to track RBI policy meetings as well as macroeconomic indicators for the direction of liquidity and bond yields. The intersection of trends in global money flows and domestic currency dynamics suggests India’s bond market is going to remain active, reacting to the central bank actions.
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