By: Suyash Choudhary
The RBI has announced a new tool for liquidity creation and decided to inject rupee liquidity for 3 years through long-term foreign exchange Buy/Sell swap. Under this, the RBI will buy up to USD 5 billion from the market via auction on 26th March, and simultaneous sell it back to the same counterparties effective March 2022. Whatever amount of dollars get mopped up via these operations will reflect in RBI’s foreign exchange reserves for the tenor of the swap while also reflecting in RBI’s forward liabilities. Meanwhile, the system gets rupee equivalent liquidity for the same amount and for the same duration.
Given the novelty of the tool and the unexpected announcement, market interpretation of this is still fluid. The first movers are a fall in USD/INR forward premium as well as a reasonable rally in front end corporate bonds. A lower hedge cost should incrementally incentivize off shore flow into Indian ‘carry’ assets (corporate bonds chiefly). The imponderable still is whether the system will be able to tender the whole USD 5 billion in the current auction. An underlying context, however, is the recent revival in dollar flows from portfolio investors also augmented by hopes of one time purchases under the domestic stressed asset resolution process. Also, once the tool is introduced, it is quite likely that the RBI follows this up with further such auctions. If so, then cost of hedge may remain better anchored for the longer term thus making rupee assets that much more attractive. A first reaction of the move also is that the new tool implies that many fewer OMOs. This means that the steepening tendency of the yield curve that has been in play for most of this calendar year persists for now.
From a more medium term perspective, this may also imply that the RBI is stepping up efforts for transmission. This move, although unconnected, comes close on the heels of the country’s largest public sector bank linking its rates on savings deposits as well as on cash credit lines to the repo rate. That move has also been hailed as a significant step in the direction of ensuring better transmission of monetary policy. If RBI has indeed stepped up efforts in this direction, it is very consistent with our expectations from the new Governor. We had outlined in a recent note our assessment that monetary policy has turned more emphatic under Mr. Das and that it was possible to envisage the central bank turning even more proactive on liquidity. We had also concluded that this seemed the right approach for now given the global backdrop and the muted local growth-inflation mix (https://www.idfcmf.com/insights/policy-puts-start-re-emerging/).
We have been continuously flagging that 2 – 5 year AAA corporate bonds offer the best risk-reward on the yield curve. This move further enhances their appeal on the margin. Investors should ensure that they don’t get so side-tracked by the worries in the credit market that they miss out on the clear opportunities in the quality part of the fixed income market.
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