New Delhi: The Reserve Bank of India will sell government bonds worth 1 trillion rupees, or about $10.5 billion, in three auctions as it moves to absorb a large surplus of cash in the banking system.
The central bank announced the plan on September 11 after a review of current and changing liquidity conditions. It will sell bonds worth 500 billion rupees on September 17, followed by sales of 250 billion rupees each on September 21 and September 28.
The move comes as India's banking system faces more than 10 trillion rupees in surplus liquidity. The large amount of cash has pushed short term interest rates below the Reserve Bank’s policy rate and created a challenge for the central bank as it manages conditions in financial markets.
The first auction will include government securities maturing between 2029 and 2032. The three auctions will together account for 1 trillion rupees.
The announcement follows earlier efforts by the central bank to absorb surplus funds through short term liquidity operations and foreign exchange swaps.
The recent liquidity increase is closely linked to a special foreign currency deposit programme introduced by the Reserve Bank. Indian banks raised about $127 billion through Foreign Currency Non Resident Bank deposits under the programme between June 8 and August 31.
Across several foreign currency mobilisation schemes, the total amount raised was about $136.38 billion during the period.
The inflows also strengthened India's foreign exchange position. The country's foreign exchange reserves rose by about $45 billion in the week ending September 4 to a record $785.7 billion.
At the same time, the large foreign currency inflows contributed to a substantial increase in rupee liquidity in the banking system.
The Reserve Bank has been using variable rate reverse repo operations and other measures to absorb the excess funds. Governor Sanjay Malhotra said on September 11 that the central bank had several tools available to manage liquidity, including open market operations and foreign exchange swaps.
Malhotra said that nothing was off the table as the central bank considers different measures to manage liquidity.
The Reserve Bank has kept its policy repo rate at 5.25 percent. The bond sales are a liquidity management measure and do not represent an increase in the policy interest rate.
The large liquidity surplus has affected short term money market rates. The weighted average call rate has fallen below the policy repo rate as banks have had large amounts of cash available.
The bond market also reacted to the announcement. India’s benchmark 10 year government bond yield rose above 7 percent on September 11, reaching about 7.04 percent.
Higher bond yields could increase borrowing costs for the Indian government if the rise continues. The impact will depend on investor demand during the upcoming auctions and wider market conditions.
The Reserve Bank is therefore trying to reduce excess cash in the banking system while limiting disruption to financial markets.
The move also comes as the Indian rupee faces pressure against the US dollar and oil prices remain high.
Higher oil prices can increase India’s import bill, put pressure on the rupee and add to inflation because India imports most of the crude oil it uses.
India is due to release its August consumer inflation figures on September 14. Economists expect inflation to have risen to about 4.8 percent from 4.45 percent in July. The 4.8 percent figure is a forecast and is not the official August inflation rate.
The inflation data will be closely watched alongside developments in the currency and bond markets as investors assess the outlook for the Reserve Bank’s monetary policy.
The first bond sale, worth 500 billion rupees, will take place on September 17. Further sales of 250 billion rupees each are scheduled for September 21 and September 28.
Investors will watch the auctions for signs of demand for government debt and their effect on bond yields and banking liquidity.
The Reserve Bank has not announced any additional bond sales beyond the three scheduled auctions. It has also not announced a change in the policy repo rate.
The upcoming operations will provide an important test of how effectively the central bank can reduce surplus liquidity while keeping short term interest rates aligned with its monetary policy framework.