India’s Rupee Strengthens as RBI Tightens Policy; Bonds Plunge

India’s rupee advanced the most this month after the central bank raised two interest rates to support the currency, which sank to a record this month. Bonds plunged the most since 2009 and stocks fell.

The Reserve Bank of India increased the marginal standing facility rate and the bank rate to 10.25 percent from 8.25 percent late yesterday in Mumbai, according to a statement on its website. The monetary authority also said it will conduct open-market sales of government debt totaling 120 billion rupees ($2 billion) on July 18, a step that would drain cash from an economy expanding at the slowest pace in a decade. The RBI held its benchmark repurchase rate at 7.25 percent.

“While the move is marginally positive for the rupee, through the carry channel, a key variable to monitor in the coming days is equity flows,” analysts at Barclays Plc, including Singapore-based Rohit Arora, wrote in a research report today. “The de facto tightening amid sluggish growth could be taken negatively by equities resulting in lower inflows.”

The rupee strengthened 1 percent to 59.32 per dollar in Mumbai, the biggest gain since June 28, according to prices from local banks compiled by Bloomberg. The currency, which fell to a record 61.2125 on July 8 after the U.S. signaled it may pare stimulus this year, earlier today touched 59.1250, the strongest level since July 1.

Bonds Plunge

The RBI also said it will cap the amount it will lend to commercial banks through the daily repurchase window to around 750 billion rupees, compared with an average 872 billion rupees borrowed each day this year through July 15, according to the monetary authority’s data.

“These measures should not be read as a prelude to any policy rate changes,” Finance Minister Palaniappan Chidambaram told reporters in Jaipur today. “These measures in no way affect our commitment to growth. Measures are taken to quell excessive speculation and reduce volatility and stabilize the rupee.”

The yield on the 8.15 percent bonds due June 2022 jumped 52 basis points, or 0.52 percentage point, to 8.2 percent, according to the central bank’s trading system. That is the biggest yield increase for a benchmark 10-year security since January 2009. The S&P BSE Sensex share index declined 0.9 percent to 19,851.23.

“The RBI’s announcement overnight will make it more expensive to short the rupee,” said Khoon Goh, a senior strategist at Australia & New Zealand Banking Group Ltd. in Singapore, referring to bets that the currency will decline. “While I expect the rupee to gain a temporary reprieve, depreciation pressure will re-emerge if the economic fundamentals don’t improve in the near term.”

Carry Costs

The carry costs of holding long-dollar positions will increase “significantly,” analysts at HSBC Holdings Plc, including Dominic Bunning in Hong Kong, wrote in a research report today. Foreign-exchange implied yields have rarely exceeded 10 percent, they wrote.

The price of contracts that fix the conversion rate for buying dollars with rupees in a year’s time jumped 111 basis points today to an annualized 7.49 percent over the spot rate, data compiled by Bloomberg show. The onshore forward premium on the dollar has risen 183 basis points in the past year.

Three-month onshore rupee forwards rose 0.6 percent to 60.47 per dollar, data compiled by Bloomberg show. Offshore non-deliverable contracts rose 1.1 percent to 60.39. Forwards are agreements to buy or sell assets at a set price and date. Non-deliverable contracts are settled in dollars.

The spread between the one-month and 12-month NDFs rose to 395 pips, the highest level since 2008. A pip is the smallest unit of a currency’s price, which in U.S. dollar terms equals one-hundredth of a cent.

The central bank said it will “continue to closely monitor the markets, the liquidity situation and the macroeconomic developments and will take such other measures as may be necessary, consistent with the growth-inflation dynamics and macroeconomic stability.”

“Some more decisions” are “on the anvil,” Finance Minister Chidambaram said today.

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