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RBI Drains Liquidity: Bond Supply Cut Signals OMO Shift
28 Sep
Summary
- Central bank bond sales have reached record levels this fiscal year.
- Reduced supply of three and five-year debt signals increased OMO activity.
- Overnight rates are below the RBI policy rate due to excess liquidity.
The Reserve Bank of India (RBI) is implementing measures to withdraw liquidity from the nation's banking system. This fiscal year, the central bank has recorded its largest annual net bond sale in over a decade, amounting to 1 trillion rupees. Market participants anticipate this figure could double by December, with projections of further open-market operations (OMO) sales.
This liquidity withdrawal follows a period where banks were encouraged to raise dollars, leading to an influx of cash that bolstered foreign exchange reserves and supported the rupee. However, this excess liquidity has depressed overnight rates below the RBI's policy rate. The recent reduction in the supply of three and five-year debt maturities is seen as a precursor to more aggressive OMOs.
Treasury heads suggest additional OMO sales or a hike in the cash reserve ratio are likely, consistent with a tighter monetary policy. Meanwhile, the government is increasing its borrowing via longer-term securities, potentially elevating term premiums in the near future. The RBI aims to flatten the yield curve at the shorter end through liquidity drainage and rate recalibration.
