News

The Reserve Bank of India's plan to buy 1.25 trillion rupees ($14.66 billion) of bonds in May will likely lower the cost of overnight interbank funds, effectively acting as a rate cut, according to analysts.

The debt purchases are likely to increase the liquidity in the banking system, helping transmit the two rate cuts announced this year and also keep the effective cost of funds below the policy repo rate of 6.00%.

When the RBI buys bonds, it injects liquidity into the banking system, making it cheaper for lenders to borrow from each other overnight. This reduces overnight interbank lending rates, which are key short-term interest rates in the economy.

CONTEXT

The RBI, under Governor Sanjay Malhotra, who took charge in December, has flooded the banking system with liquidity. The bond purchase plan in May will follow purchases of 1.20 trillion rupees in April and 2.83 trillion rupees in January-March.

The central bank is targeting bond purchases amounting to a surplus of around 1% of deposits, Malhotra said earlier this month, which works out to about 2.30 trillion rupees to 2.50 trillion rupees.

MARKET REACTION

The weighted average overnight call money rate was at 5.93% on Tuesday but is expected to ease to 5.75%, the rate offered by the RBI to banks parking excess funds at the Standing Deposit Facility (SDF).

Indian government bond yields declined on Tuesday after the May debt purchase plan was announced, with the 10-year bond yield hitting a low of 6.32%, after rising to 6.40% a day prior.

KEY QUOTES

With sufficient domestic liquidity, we can expect the weighted average call rate to fall further and align closely to the SDF rate, said Aditi Gupta, economist at Bank of Baroda.

It seems that for now, the RBI's intent is to target the quantum of durable liquidity and take it to at least 1% of deposits, with enough tolerance for higher values, Samiran Chakraborty, Citi's India chief economist, said.

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