Reserve Bank of India on Friday (October 6) announced consideration of open market operations The sale of government securities to manage liquidity in the (OMO) system took the bond market by surprise as the central bank did not give any specific timeline for the offer. In response, the yield on the benchmark 10-year government bond rose 12 basis points to 7.34 percent as the market expects OMOs soon, which is expected to strengthen liquidity in the system.
Although there is no clear calendar for this, now a long sword is hanging that such OMO can be announced any day. “This is particularly because the market understands that the October-December quarter is likely to have the best liquidity. By then core liquidity may be so low that RBI may not want to continue OMOs from the next quarter. Thus, the risk of this excess supply is higher in the near term, and its impact may weigh more on the minds of market participants,” said Suyash Chaudhary, Head – Fixed Income, Bandhan AMC.
Although retail inflation stood at 6.83 per cent in August, the market did not expect the RBI’s move to drain excess liquidity, which would lead to monetary policy aggression. Liquidity is expected to reduce due to cash withdrawal from the banking system due to the upcoming festival season. “Going forward, while remaining nimble, we may have to consider OMO sales to manage liquidity, in line with the monetary policy stance. The timing and quantum of such operations will depend on the emerging liquidity conditions, RBI Governor Shaktikanta Das said while unveiling the monetary policy.
What is OMO?
The RBI uses Open Market Operations (OMO) to adjust the liquidity position of the rupee in the market on a sustainable basis. When the Reserve Bank feels that there is excess liquidity in the market, it resorts to sale of government securities, thereby draining the rupee of liquidity. Similarly, when liquidity conditions are tight, the central bank purchases securities from the market, thereby releasing liquidity into the market. It is used as a tool to rein in inflation and money supply in the system. However, when liquidity dries up, it may lead to a rise in bond yields as the RBI will release more government securities in the market and bond buyers will demand higher interest rates on these securities.
Why does RBI want OMO?
Although the specific OMO calendar has not been released, the RBI Governor stressed the bank’s intention for “active liquidity management” in the post-policy press conference. This indicates the RBI’s inclination towards tighter liquidity conditions in the future, influenced by both inflation risks and financial stability concerns. This stance is in line with the central bank’s goal of keeping inflation stable at 4 percent. According to Amneesh Aggarwal, head of research, Prabhudas Lilladher Pvt Ltd, the RBI’s approach is clear: merely keeping inflation below the upper band of the target range (at 6 per cent) is insufficient, a more proactive approach is necessary.
The central bank wants to use liquidity management to achieve the target. Historically, the October-May period has seen higher cash outflows due to the festival and wedding season. This generally reduces sustainable liquidity in the banking system, which now appears to be RBI’s area of focus under liquidity management. Thus, the mention of OMO sale at this stage was a bit of a surprise and it leaves the window open for speculation about the level of liquidity at which RBI may plan the OMO sale and its volume, said fund manager Pankaj Pathak. Said- Fixed Income, Quantum AMC.
most Read
Israel-Palestine conflict live updates: At least 480 Israelis and Palestinians killed; Hamas says it has captured many Israelis
Threat to kill PM, blow up Modi stadium: Security agencies on alert after email demands Rs 500 crore and release of Lawrence Bishnoi
What is the liquidity situation now?
The RBI Governor indicated that the RBI may opt for OMO sale auction of government securities to prevent any creation of excess liquidity. RBI has been selling OMOs in the secondary market since last month, with net sales in September standing at Rs 6,200 crore.
The RBI had implemented incremental cash reserve ratio (I-CRR) in the August MPC meeting, which resulted in a liquidity drain of Rs 1.1 lakh crore from the banking system. Despite the gradual recovery of I-CRR, systemic liquidity remained in deficit since mid-September due to quarterly tax outflows and GST payments. Advance tax payments have resulted in an increase in the government’s cash balance with the RBI, which is estimated to be around Rs 2.7 lakh crore. Systemic liquidity could be boosted by increased government spending in the second half and withdrawal of I-CRR. However, according to Care Ratings, a surge in demand for the currency ahead of the festive season could offset any increase in systemic liquidity.