The Reserve Bank of India announced new liquidity measures to stabilize the money markets and contain recent increases in borrowing costs.
The move was made at a time of tightening liquidity in the banking system, rising bond yields and increased pressure on the rupee.
By announcing a combination of government bond purchases, and a foreign exchange swap, the central banks signaled its intent to smooth out market conditions, and counter recent cash leaks, triggering an all-encompassing bond rally.
The RBI announced on Tuesday evening that they will be purchasing 2 trillion rupees worth of government bonds over four tranches in December and January.
It also announced that a $10 billion foreign exchange swap will be conducted next month.
The benchmark 10-year government bond rate fell to 6.54% following the announcement, marking its steepest single-day drop since Aug. 14.
Liquidity boosts bond rally
The RBI’s liquidity support has been significantly increased by the bond purchases.
The central bank is concerned about tightening of financial conditions, as evidenced by the fact that the planned infusion will be double the amount announced earlier in the month.
The markets were under pressure this week after the benchmark yield reached a nine-month peak, indicating concerns about liquidity.
Bloomberg reported that experts said the measures had changed the near-term dynamics of yields, and many now see room for the 10-year rate to ease towards the 6.50% range.
The rally was broad and reflected improved sentiment across maturities, as expectations of continued liquidity support took root.
Cash Drain due to Rupees: Offset
The latest steps have as a key objective to counteract the impact of RBI interventions on the foreign exchange market.
The central bank has sold dollars to support rupees, which has become Asia’s worst performing currency this year.
These dollar sales have drained liquidity from the rupee system, increasing pressure on short-term funding markets.
The foreign-exchange exchange swap, along with bond purchases, should help replenish liquidity, while allowing RBI to continue managing currency fluctuations.
These measures are also being taken as lenders face seasonal pressures due to tax-related outflows which have further tightened the cash conditions.
Bloomberg data shows the banking system liquidity fell into a deficit on Dec. 22, reaching 727 billion rupees.
This is a dramatic change from the surplus of 2.6 trillion rupiahs that was seen earlier in this month.
The shift has increased overnight borrowing costs for the banks, causing stress on money markets.
The RBI’s actions seem to be designed to prevent these pressures spilling over into wider financial conditions, especially at a moment when global factors such as punitive US Tariffs are weighing down on growth-sensitive investments.
Market positioning is a powerful tool.
Recent positioning data also supported the bond rally.
After the trading ended on Tuesday, figures released showed that a group of market participants, which included the RBI, had purchased 47,4 billion rupees in government notes.
This was the largest such buying since November 11, and provided an additional reassurance that official support is being given to the market.
This post Indian government bonds surge as RBI steps in ease liquidity strain may be updated as new developments unfold.
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