India reported its highest fx reserves at USD 400.7 billion as of 8th September 2017 despite current account deficit jumping to 2.4% of GDP in the 1st qtr of this fiscal year from 0.1% of GDP and 0.6% of GDP in the 1st and 4th quarter of last fiscal year respectively. CAD was at USD 14.3 billion 1st qtr of this fiscal year against USD 0.4 billion (1st qtr of fiscal 2016-17) and USD 3.4 billion 4th quarter of last fiscal, Sharp rise in FDI and FII inflows at USD 7.2 billion (USD 3.9 billion in 1st qtr of fiscal 2016-17) and USD 12.5 billion (USD 2.1 billion in 1st qtr of fiscal 2016-17) more than made up for the rise in CAD.
The result of sharp rise in capital flows is RBI accumulating fx reserves. RBI has bought USD 11.82 billion in the April-July 2017 period and have a forward outstanding purchase of USD 26 billion. RBI has been accumulating forwards to prevent a sharp rise in the INR and also to limit the immediate liquidity impact of spot purchases. Hence when the forwards come up for maturity, fx reserves will swell by USD 26 billion and liquidity of around Rs 1600 billion will be added into the system.
Forward premia is holding on at levels of around 4.3% largely due to RBI forward buying. If RBI lets up, premia can crash and that will have a knock on effects on money market yields. OIS yields can fall sharply below repo levels.
RBI in its October 2017 policy review will need to assess the impact of its fx operations as it sets policy rates. Though CPI inflation trended higher in August, real rates of interest are too high and money market yields are being artificially held high on forward intervention.
Government bond yields rose last week on rising CPI inflation lowering rate cut expectations. The new benchmark 10 year bond, the 6.79% 2027 bond saw yields close up by 5bps week on week at levels of 6.59%. The on the run bonds, the 6.79% 2029 bond and the 6.68% 2031 bond saw yields close up by 3bps and 7bps respectively to close at 6.87% and 6.72%. The long bond, the 7.06% 2046 bond saw yields close up by 3bps at levels of 7.11%. Gsec yields will fall on rate cut expectations though yields could be pressured in the near term on October policy worries.
The OIS market saw 5 year OIS yields rose by 9bps week on week to close at levels of 6.25%. The one year OIS yield rose by 3bps to close at 6.15%. OIS yields will fall on rate cut expectations and on expectations of forward premia coming off.
System liquidity as measured by bids for Repo, Reverse Repo, Term Repo and Term Reverse Repo in the LAF (Liquidity Adjustment Facility) auctions of the RBI and drawdown from Standing Facilities (MSF or Marginal Standing Facility and Export Credit Refinance) and MSS bond issuance was in surplus of Rs 3598 billion as of 15th September 2017. The surplus was Rs 4486 billion as of 1st September. Advance tax outflows led to fall in system liquidity.