India’s move to rein in rupee gains and rebuild foreign-exchange reserves is flooding the financial system with cash, driving bank funding costs to a 10-month low.
The three-month interbank lending rate fell 87 basis points this quarter to 8.90 percent on May 26, exchange data show. A similar gauge in China is at 4.98 percent. The currency stockpile jumped $40 billion from a three-year low in September to $315 billion, and Nomura Holdings Inc. estimates the central bank’s dollar purchases pumped about 800 billion rupees ($13.6 billion) into markets in the four months through April.
Reserve Bank of India Governor Raghuram Rajan is boosting reserves as U.S. stimulus cuts threaten to spur fund outflows from emerging markets. Falling funding costs may help new Prime Minister Narendra Modi revive growth in Asia’s third-largest economy from close to a decade-low and improve public finances.
“The central bank’s dollar buying should be an important source of liquidity creation in the banking system from here on, exerting downward pressure on swap rates and bond yields,” Vivek Rajpal, a Singapore-based rates strategist at Nomura Holdings, said in an e-mail interview yesterday.
The three-month interbank rate has retreated 263 basis points, or 2.63 percentage points, from a five-year high of 11.59 percent reached in September, when the RBI had tightened cash supply to arrest a rupee plunge. The currency, which fell to a record 68.845 per dollar in August, has since rebounded 17 percent, touching an 11-month high of 58.3350 on May 23 after national elections delivered the clearest verdict in 30 years.
Increased confidence in the rupee has attracted $14.6 billion of inflows into local stocks and bonds this year, allowing the central bank to step up dollar purchases and lift reserves above $300 billion for the first time since 2011. As cash supply increased, lenders’ overnight borrowings from the RBI to meet shortages declined to an average of 89 billion rupees so far in May from 123 billion rupees in April.
“Intervention is significant to the extent that you don’t have any funding concerns and there’s no liquidity premium being built at the short-end of the yield curve,” Rajeev Radhakrishnan, head of fixed income in Mumbai at SBI Funds Management Pvt., which manages about 663 billion rupees, said in a May 26 phone interview. “The central bank’s thrust would be to ensure that the overnight rate remains closer to the 8 percent repo rate. That would keep the short-end rates lower.”
The overnight interbank borrowing rate has dropped to 8.20 percent today from 11 percent at the end of the last quarter, according to data compiled by Bloomberg.
Increased cash supply has bolstered demand for government bonds, driving the yield on the benchmark 8.83 percent notes due 2023 to a four-month low of 8.64 percent last week. The rate was little changed at 8.68 percent today, while the rupee weakened 0.1 percent to 59.1025 per dollar. Holdings of sovereign bonds at local banks rose 3.5 percent in 2014 to 22.9 trillion rupees as of May 2, the latest RBI data show.
The drop in the government’s borrowing costs would help its efforts to cut the budget deficit. The shortfall likely narrowed to 4.6 percent of gross domestic product in the year ended March 31 from 4.9 percent in the prior 12 months, former Finance Minister Palaniappan Chidambaram estimated in February. He forecast the gap for the current period at 4.1 percent.
Arun Jaitley, who took charge at the finance ministry yesterday as part of the Modi government, told reporters in New Delhi that his priorities include restoring economic growth, containing inflation and fiscal consolidation.
Bond risk in India is falling. Credit-default swaps insuring the notes of State Bank of India, a proxy for the sovereign, against non-payment for five years fell 64 basis points this month to a one-year low of 188, according to data provider CMA.
Sustained currency-market intervention by the RBI may end cash shortages at banks, prompting lenders to halt overnight borrowings from the central bank, according to Barclays Plc.
“Net dollar purchases by the RBI could move banking-system liquidity from deficit into surplus,” Barclays analysts Rohit Arora and James Lee wrote in a note dated May 21. Lower funding costs “should restore confidence in the fixed-income markets,” they wrote.