Markets are panicking. The Food Security Bill and the Syria issue have taken the Indian Rupee (INR) to all time lows of Rs 68.75 to the US Dollar. The INR is down over 10% over the last ten days. Ten year benchmark bond yields have gone up by 70bps while the Sensex and Nifty are down 10% from levels seen over the last ten days.
RBI has no reason to continue with its tight liquidity policy that it introduced on the 15th of July 2013 when the INR was trading at levels of around Rs 60. RBI’s moves to take up overnight money market rates to 10.25% have resulted in yields at the short end of yield curves going up by 300bps. Long bond yields including ten year benchmark government bond yields have risen by 150bps.
The bond market is swamped with supply at a time when liquidity is tight and the INR is on a free fall. RBI must realise that it has absolutely no control over the INR and all its liquidity tightening efforts have only created more panic in the markets.
Bond market this week has seen supply of Rs 22,000 crores of Cash Management Bills, Rs 1000 crores of IIB (Inflation Indexed Bonds) and Rs 8800 crores of State Development Loans (SDL). The market will have to absorb Rs 17,000 crores of government bond supply in the auction scheduled for Friday the 30th of August. RBI buying bonds in the OMO (Open Market Operation) purchase auction for Rs 8000 crores scheduled for the 30th of August will hardly help ease tension in the market.
Bond market has no appetite to absorb supply of bonds and money market securities. The IIB auction held on the 27th of August saw over 50% of the auction devolving on the Primary Dealers at a price of Rs 83.30 implying a real yield of 3.47%. 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.
Ten year benchmark bond yields, the 7.16% 2023 bond is trading at levels of 9%. The bond yield touched five year highs of 9.45% on the 20th of August before RBI announced OMO purchase action to bring down the yields. The bond yield touched lows of 8.20% on the 22nd of August 2008 before climbing back to levels of 9% on the back of the panic over Food Security Bill and the Syria issue.
The need of the hour for markets is not INR damage control measures. The RBI and the Government must have by now realized that the INR 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.
RBI should withdraw the limit of 0.5% of NDTL placed on banks on access to Repo funds under LAF (Liquidity Adjustment Facility). RBI should bring back MSF (Marginal Standing Facility) rate to 100bps over repo from 300bps over repo. The system requires liquidity at present and the comfort of liquidity can lessen the panic that is prevailing in the market at present.
RBI reversal of its tight liquidity stance will not fully stem the nervousness in markets but it can at least stop it from causing more damage to market sentiments that are hurt by issues beyond its control.