Bond sales, FX swaps among RBI's options to drain excess liquidity, governor tells

MUMBAI/BENGALURU: The Reserve Bank of India is reserving all options when it comes to managing liquidity and aligning the overnight rate with the key repo rate, stated Governor Sanjay Malhotra in an interview with CNBC-TV18 on Friday. Among the tools at its disposal, bond sales and foreign exchange swaps emerged as significant options for draining excess liquidity.

Malhotra explained that some of the surplus liquidity in the banking system would be gradually withdrawn through foreign exchange interventions and adjustments to banks' reserve requirements, driven by rising credit growth. The central bank's primary objective remains maintaining appropriate liquidity conditions. "We possess ample tools to handle liquidity, aside from variable rate reverse repos, including open market operations or FX swaps," Malhotra emphasized.

"Nothing is off the table." Lenders in India amassed a substantial $127 billion in surplus cash through the RBI's special forex mobilisation scheme, pushing central bank reserves to record highs. Nonetheless, this excess rupee liquidity has driven overnight rates below the policy repo rate, prompting the central bank to intensify liquidity absorption as rising oil prices risk spiking inflation.

India's banking sector witnessed a liquidity surplus of over 10 trillion Indian rupees this week. Malhotra acknowledged the RBI's cautious approach regarding the withholding of cash reserve ratio requirements on overseas FX deposits, a standard practice. "We will, of course, refrain from imposing a higher CRR or a similar CRR on those deposits," he affirmed.

Liquidity absorption via FX swaps serves as a support mechanism for the rupee, Malhotra noted. Bond yields have been climbing following the mention of debt sales as a potential remedy for rupee liquidity, reaching their highest levels in over three months. The benchmark 10-year bond yield increased to 7.035%, a 6 basis points rise from the previous day, while the 5-year counterpart surged by up to 10 basis points to 6.6222%.

The RBI might introduce an open market bond sale as early as next week, encountering two obstacles: banks' reluctance towards longer-duration operations and the increased forex hedging costs associated with dollar-rupee swaps, according to four bankers interviewed on Friday. The monetary policy stance was deemed "appropriate" by Malhotra, who indicated that the nation's rate-setting panel would evaluate growth-inflation dynamics during their meeting next month.

The central bank has taken inflation expectations, including the surging food prices, into account while formulating its inflation projections. The RBI's inflation forecast for the current fiscal year stands at 5%, a level 5 percentage points higher than the previous month, with a medium-term target of 4%. While global bond yields have surged due to elevated debt loads and inflation expectations, India's conditions remain distinct.

Since the Iran war commenced in February, India's 10-year bond yield has risen by 37 basis points, compared to 98 basis points in the U.S. and 87 basis points in Japan.