By Gaurav Kulshreshtha | 08 MAY 2018
RBI’s announcement to conduct Open Market Operations (OMO) bond purchase to the tune of INR 10,000 crores (to be held on the 17th of May) and inject durable liquidity into the banking system surprised many market participants. While Citi economists were anticipating OMO purchases by RBI this fiscal however the timing of this announcement did surprise them as well, given that the banking system liquidity is still at a moderate surplus (~INR 40,000 crore).
Since the 5th April RBI policy, banking system has seen close to ~INR 95,0000 – 1,00,000 crores being drained out on account of increase in currency in circulation as well as due to RBI’s FX intervention following some FPI outflows. Hence Citi economists believe that this OMO purchase announcement should be viewed as merely replenishing the durable liquidity that got drained and not as a signal on yields in response to recent bond market volatility.
Citi economists believe that this is not a one-off announcement and more OMO purchases will follow in the current fiscal year, even though the timing of these announcements may be tactically managed by RBI. They estimate OMO purchases to the tune of ~INR 50,000 - 1,00,000 crore in FY19.
Since this OMO purchase was announced at a time when 10 yr yields were again testing their recent highs, some market participants may view this as a signal from the policy makers regarding their discomfort with wider risk premiums. Indeed, the bond market has rallied over the past two days (Ref. chart above). However, Citi economists believe that the rally may be short lived and investors would start focusing back on the medium term challenges viz. hawkish RBI, wider current account deficit, fiscal risks that are further exacerbated by rising crude oil prices. Clients with significant overexposure to duration may use this rally as an opportunity to reduce duration and become more diversified in their fixed income portfolios. We continue to focus on the short to medium end of the yield curve.