The Finance Minister, Prime Minister and the RBI Governor have collectively decided to take government bond yields higher in order to curb the volatility in the Indian Rupee (INR). RBI has announced measures to stem INR fall that had fallen to record lows of Rs 61.21 in intraday trading last week.
RBI’s preventing INR fall measures include a) Sucking out liquidity through OMO (Open Market Operation) sale auction of government bonds b) Increasing cost of liquidity by hiking MSF (Marginal Standing Facility) rate to 300ps over repo from 100bps over repo and c) Limiting LAF (Liquidity Adjustment Facility) allocation to Rs 75,000 crores (around 1% of NDTL or Net Demand and Time Liabilities of Banks).
RBI’s actions will take up overnight money market rates to over 10% as bank borrowing in LAF was over Rs 90,000 crores on the 15th of July. The OMO sale auction will drive up bond yields and the 7.16% 2023 government bond will see yields rise to 8% from current levels of 7.56%.
RBI’s belief that excess liquidity is causing INR volatility is completely misguided. The fact that banks are borrowing money from the RBI on a daily basis suggests that liquidity is in deficit. RBI has theorized that speculators are borrowing INR at around repo rates and are buying USD to profit from INR weakness.
RBI could well have just refused bids for repo than announce measures that will actually cause more debt sales by FII’s as bond yields rise. INR can in fact fall further on the back of these measures.