In the near term bonds and the Rupee will react positively to the OMO announcement as bond markets will not fret on absorbing weekly supply of Rs 15,000 crores while the currency market will see the move as prospects of aggressive intervention by the RBI. The question is whether RBI will come out with more OMO’s or is this one just a signal to the markets that the central bank is watching the situation and will step in when necessary.
RBI announced a surprise OMO (Open Market Operation) purchase auction for Rs 12,000 crores. The auction to be held on the 11th of May will help calm bond markets that were worried on the liquidity impact of a falling Rupee. Bond yields closed Monday the 7th May at one month highs with the ten year benchmark bond the 8.79% 2021 bond yield closing at 8.69% levels. The Rupee has fallen over 6.5% from levels seen in February 2012 on risk aversion due to sovereign debt worries in the Eurozone.
RBI had been buying bonds in the secondary market since the beginning of fiscal 2012-13 and had bought around Rs 13,000 crroes of bonds as of 27th April 2012. The OMO announcement was not expected by the market as seen by the higher close of bond yields on Monday. The surprise OMO announcement will bring down bond yields by 20bps to 25bps taking the ten year bond yield to 8.45% to 8.50% levels.
The current liquidity conditions do not warrant an OMO with bids for repo at around Rs 112,000 crores. Overnight rates have been hovering around the repo rate of 8% as banks have ample stock of government bonds to access the repo window for funds. Hence the OMO announcement does send out signals that the RBI is either intervening directly in the currency markets to stabilize a falling INR or is planning to intervene aggressively in case the Rupee threatens to go on a free fall.
RBI last week had freed rates on foreign currency export credit and increased rates on NRI deposits to bring in more USD into the country. RBI’s moves had a positive effect on the Rupee, which moved up by 1% on Monday. The postponement of GAAR to next fiscal also helped strengthen the Rupee as fears of FII selling subsided and equities turned positive from being deeply negative in the first of the trading day.