Rupee at 68: Why RBI should reverse its illogical measures

Markets are panicking. The Food Security Bill and the Syria issue have taken the Indian rupee (INR) to all-time lows of 68.75 to the dollar. The rupee is down over 10 percent in the last ten days. The 10-year benchmark bond yields have gone up by 70 bps, while the Sensex and Nifty are down 10 percent from levels seen 10 days ago.

The RBI has no reason to continue with its tight liquidity policy that it introduced on the 15 July when the rupee was trading at levels of around 60.

The RBI's moves to take up overnight money market rates to 10.25 percent have resulted in yields at the short end of yield curves going up by 300 basis points. Long bond yields, including those on 10-year benchmark, have risen 150 bps.


The RBI has no reason to continue with its tight liquidity policy that it introduced on the 15 July when the rupee was trading at levels of around 60. Reuters

The bond market is swamped with supply at a time when liquidity is tight and the rupee is on a free fall. The RBI must realise that it has absolutely no control over the rupee and all its liquidity tightening efforts have only created more panic in the markets.

The bond market this week has seen supply of Rs 22,000 crores of cash management bills (CMB), Rs 1,000 crores of inflation indexed bonds (IIBs) and Rs 8,800 crores of state development loans (SDL).

CMBs are short term instruments with maturities less than 91 days issued to raise funds for the government. SDLs are bonds issued by various state governments.

Apart from these, the market also has to absorb the Rs 17,000 crore government bond supply in the auction scheduled for 30 August. The RBI's OMO (open market operation) purchase auction, where in it would buy bonds for up to Rs 8,000 crores on 30 August, will hardly help ease the tension in the market.

The bond market has no appetite to absorb supply of bonds and money market securities. The IIB auction held on 27 August saw over 50 percent of the auction devolving on the primary dealers at a price of Rs 83.30 implying a real yield of 3.47 percent. The IIB closed at Rs 81.49 post auction. The IIB was first issued at real yields of 1.44% for Rs 100 face value in the first week of June 2013.

Primary dealers are the underwriters and buy bonds that do not find takers at the auction.

The yield on the 10-year benchmark bond--the 7.16% 2023 bond--is trading at levels of 9 percent. The bond yield touched five-year highs of 9.45 percent on 20 August before the RBI announced the OMO purchase action to bring down the yields.

The bond yield touched lows of 8.20 percent on 22 August before climbing back to levels of 9 percent on the back of the panic over Food Security Bill and the Syria issue.

The need of the hour for markets is not rupee damage control measures. The RBI and the government must have by now realised that the rupee is not in their hands in the short term.

Instead policy makers should work towards easing the panic situation in the market that is seeing prices fall drastically across equities and bonds.

The RBI should withdraw the limit of 0.5 percent of NDTL placed on banks to access its LAF (liquidity adjustment facility) window. To meet liquidity requirements, banks usually access this window through which the RBI lends money to banks against the government bonds.

The RBI should bring back MSF (marginal standing facility) rate to 100bps over repo rate from the present 300bps. MSF is another facility, which the banks access when they do not get enough funds from LAF. The system requires liquidity at present and the comfort of liquidity can lessen the panic that is prevailing in the market at present.

The reversal of RBI's tight liquidity stance will not fully stem the nervousness in markets but it can at least stop it from causing more damage to the sentiment that are hurt by issues beyond its control.

Arjun Parthasarathy is the Editor of a web site for investors.

Updated Date: Dec 20, 2014 22:00 PM

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