RBI latest Monthly Bulletin released on the 10th of September 2014 reveals that the central bank was net buyer of spot USD 5.45 billion and net buyer of forward USD 5.4 billion in July 2014. RBI has bought spot USD 15.75 billion in the April-July 2014 period, leading to an infusion of Rs 922 billion of liquidity into the system. RBI forward position is net purchase of USD 5.4 billion against net sale of USD 32 billion in April 2014. Net forward purchase is liquidity positive on maturity of forward contracts.
The Rs 922 billion of liquidity infusion in the system has not led to system liquidity turning into surplus and that is largely due to the high cash balance the government is running with the RBI. Government cash balance is estimated at around Rs 500 billion. Liquidity as measured by banks bids for LAF (Liquidity Adjustment Facility) repo, reverse repo and term auctions, banks drawdown from MSF (Marginal Standing Facility) and Export Credit Refinance was at deficit of Rs 527 billion as of 12th September 2014.
Government surplus will increase further on advance tax outflows this week. Tax outflows could be around Rs 700 billion and that will go out of the system post the 15th of September. Government surplus would move up to levels of Rs 1200 billion on advance tax outflows.
In order to alleviate liquidity deficit brought about by advance tax outflows, the government is undertaking a buyback of its bonds for Rs 200 billion on the 16th of September 2014.
If the market tenders bonds for the full amount and the tenders are accepted, system liquidity would ease by Rs 200 billion.
Government bond yields fell marginally week on week with the benchmark ten year bond, the 8.40% 2024 bond, seeing yields fall by 2bps to close at levels of 8.50%. Bond yields could trend down further on the back of IIP (Index of Industrial Production) growth coming in at 0.5% for July 2014 against June 2014 growth levels of 3.4%. CPI inflation for August came in at 7.8% against July levels of 7.96%. RBI is unlikely to change its stance on inflation targeting despite growth outlook not looking too certain but the bond market will factor in uncertain demand into lower inflation expectations and take down bond yields going forward.
OIS market saw the yield curve staying almost flat week on week. One year OIS yield stayed flat at 8.46% levels while five year OIS yield fell by 1bps to close at levels of 8.02%. Expected liquidity tightening in September on advance tax outflows will keep one year OIS yields at higher levels while government bond rally will bring down five year OIS yields.