India’s central bank may buy as much as 1.5 trillion rupees ($18 billion) of government bonds to replenish banking liquidity that’s expected to tighten later in the year, according to a top banker.
The Reserve Bank of India may cut the cash reserve ratio by half a point in the fiscal second half and start buying bonds in the December quarter to keep banking liquidity at current levels, B. Prasanna, group head for global markets sales, trading and research at ICICI Bank Ltd, the nation’s second-largest private lender by market value, said in an interview Monday.
Liquidity is likely to tighten in the banking system as higher spending amid state elections due later in the year may lead to money leaving the system. A number of key states like Rajasthan, Madhya Pradesh and Chhattisgarh have elections due, and that will coincide with the busy credit season in October when demand picks up in the economy.
“The currency in circulation will remain high due to a number of state elections and national elections next year,” Prasanna said. “The currency coming in will go out as people take out the cash.”
Excess liquidity in the banking system has narrowed to about 740 billion rupees from this year’s high of about 3 trillion rupees in April, according to data compiled by Bloomberg Economics. To ease the squeeze, the RBI injected about 468 billion rupees into the banking system on May 19 via a repo auction, the first such injection since March.
Still, some lenders like Kotak Mahindra Bank Ltd. have said the RBI’s withdrawal of the highest value 2,000 rupee notes from circulation this month will replenish liquidity and lower the probability of bond purchases in the fiscal second half.
The move is expected to add about one trillion rupees of banking liquidity, according to estimates. It follows the RBI’s higher-than-expected dividend payout to the government, which may also boost cash in the system.
The current liquidity addition has brought down funding rates, creating scope for a rally in notes maturing in five years and less, Prasanna said. The 5-year yield may drop to 6.8% levels, while the one-year treasury bill can fall to 6.75%, he said. The 10-year bond doesn’t have much scope for rally now with interest rates expected to having peaked, he added.