RBI To Purchase Govt. Bonds In Open Market Operations

In order to arrest the liquidity in the economy, in July 2013 the RBI announced a few measures which included increasing the short-term lending rates. While these measures were directed towards tightening liquidity to increase the demand for rupee, the intended effect never came to bear. Far from that, the rupee has moved further down to the level of 63 against the dollar. Bond yields, however, have shot up over 9%.

Rising bond yields do not augur well for an economy. In an earlier story addressing this issue (http://www.dsij.in/article-details/articleid/8200/rising-bond-yields-collateral-damage-of-the-rupee-fall.aspx), we had mentioned that the rising bond yields would lead to higher borrowing costs and that banks in particular would take a hit on their investment books due to the spurt in yields.

As per the measures announced today (August 21), the RBI will conduct open market operations (OMO) to purchase bonds worth Rs 8000 crore from the market starting August 23, 2013. The apex bank will purchase long-term securities, which are offering a coupon rate of 8.15% and maturing in 2022. As of now, it is not planning to touch bonds maturing in 2013, 2026 and 2030.

An OMO is a process of liquidity injection in the market to lower bond yields, and this will stand contrary to the earlier measure of liquidity squeezing. After this fresh announcement, the bond yields have fallen to 8.93% today.

The regulator has also allowed banks to retain Statutory Liquidity Ratio (SLR) holdings in the Held to Maturity (HTM) category at 24.5% of their Net Demand and Time Liabilities (NDTL). Earlier regulations required banks to keep their SLR securities in the HTM category at 23% of their NDTL.

Also, banks are now allowed to transfer their SLR securities to the HTM category from Available For Sale (AFS)/Held For Trading (HFT) categories upto the limit of 24.5% as a one-time measure. In addition, the RBI has allowed banks to value these securities at the lower of the book value or market value.

Following the rise in bond yields, banks are now required to report their mark-to-market losses. The RBI has allowed banks to spread this loss over the remaining period of the current financial year in equal instalments.

These measures may help the banks in the short term, but for the long-term the RBI and the government need to work in tandem and treat the disease rather than the symptoms.