MUMBAI: India's central bank may buy a record 1 trillion rupees ($17.86 billion) of bonds in the rest of this f i scal year to prevent a severe cash shortage from worsening, but yields may not fall much until interest rates are cut, a Reuters poll showed.
Views ranged from a low of 400 billion rupees to a maximum of 1.5 trillion rupees of bond purchases done via open market operations in the rest of the fiscal year ending in March 2013, according to the Reuters poll of 18 traders and primary dealers.
The projection would imply the Reserve Bank of India is on track to buy debt worth about 1.7 percent of the projected gross domestic product for fiscal 2012-13, when added to the 687 billion rupees already bought since the start of the year.
Traders view OMOs as a tactical decision to provide enough cash to banks to allow the federal government to borrow a record 5.7 trillion rupees this fiscal year, but not enough to spark inflationary pressures given the RBI's persistent dollar sales in forex markets to protect a weak rupee.
The success of the borrowing programme is crucial if India is to meet its projected fiscal deficit of 5.1 percent of GDP for fiscal 2012/13, at a time when its investment-grade rating is under threat from both Standard & Poor's and Fitch Ratings.
"OMOs infuse liquidity gradually and at RBI's discretion. So in absence of a need to inject significant liquidity in a short-time, this tool serves its purpose well," said Nagaraj Kulkarni, a senior rates strategist with Standard Chartered Bank.
The expectations for additional OMOs have increased after the RBI shocked markets by keeping policy on hold on Monday, after last cutting the repo rate by 50 basis points in April, but said it would conduct OMOs when warranted.
Open market operations are auctions in which the RBI sets the price at which it will buy, or some times sell, debt.
The central bank has also bought bonds in secondary markets to supplement OMOs, but is reluctant to cut the cash reserve ratio, which is India's main liquidity tool as it controls how much money lenders must park with the RBI. The CRR was last cut by 50 bps in March.
The RBI prefers OMOs because it considers the auctions a flexible liquidity tool not meant to target bond yields, whereas the CRR would have wider monetary policy implications.
The central bank has also been conducting OMOs to offset the liquidity impact from forex interventions in which the RBI sells dollars and buys rupees -- as it did in May when the currency fell to record lows against the dollar.
Tight cash conditions in India's financial system have been a persistent source of concern for some investors. Banks have regularly borrowed well above the RBI's comfort zone of 650 billion rupees in daily repo auctions.
Traders polled by Reuters view these bond purchases via open market capping bond yields, but they say yields are unlikely to fall much until the RBI takes the m o re active step of cutting interest rates or the CRR.
The median estimate in the poll sees the 10-year bond yield at 8.14 percent by the end of September, above the repo rate of 8 percent, and at 7.95 percent by end-December.
India's benchmark yield last traded at 8.39 percent. "CRR can prove to be an effective tool to inject significant amount of liquidity in a very short-time," said Kulkarni.
"So RBI may keep its powder dry and reserve it for difficult times," the StanChart analyst added.
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