Rupee defence dented as Rs. 12,000 crore RBI bond sale falls short

Mumbai: The Reserve Bank of India's (RBI) effort to support the rupee
by sucking liquidity from the market through a Rs. 12,000 crore bond
sale fell short on Thursday as it accepted just over one-fifth of the
bids, adding pressure on it to find other ways to mop up the currency.

The open market operation (OMO) was part of the RBI's three-pronged
plan unveiled late on Monday to prop up the rupee that has lost about
10 per cent against the dollar since the start of May.

But the other steps, including hiking short-term rates by 200 basis
points or 2 per cent, sent bond yields surging, creating a mismatch in
pricing demands. In Thursday's OMO, the RBI accepted bids for just Rs.
2,532 crore.

"This does complicate the RBI's task of managing rupee through the
liquidity channel," said Rohit Arora, emerging market rate strategist
at Barclays Capital in Singapore.

"We expect it to continue doing more OMO sales in the near term. The
other option to stabilize the rupee for the government is to issue an
offshore bond," he said.

Whatever measures the central bank takes are liable to be little more
than short-term fixes, as the rupee's weakness stems from a record
high current account deficit.
The currency's vulnerability was laid bare by the sea-change in global
capital flows following speculation that the U.S. Federal Reserve
would begin to wind down its money-printing stimulus programme later
this year, which convinced investors to pull money out of riskier
assets.

While trying to conserve its currency reserves, equivalent to just
seven months of imports, the RBI has sought to limit avenues for
speculation against the currency, to buy time for Prime Minister
Manmohan Singh's government to come up with measures to reduce the
external deficits.

A relaxation of rules for foreign direct investment (FDI) announced on
Tuesday for several industries, including telecommmunications, failed
to give big boost to sentiment.

Besides further OMOs, the RBI could try to pressure New Delhi to bite
the bullet and accept less-favourable pricing at its bond sales in
order to drain liquidity. The next such sale is due Friday. On
Wednesday, the RBI rejected all bids in a Rs. 12,000 crore Treasury
bill auction on the government's behalf.

India is also contemplating a sovereign bond issue in order to attract
inflows and prop up the rupee. An increase in the RBI's policy repo
rate at its July 30 review, once unthinkable, has also become an
outside prospect, as has an increase in the cash reserve ratio for
banks.

"The RBI's rejection of bids at the OMO and the treasury bill auction
suggests it does not want yields to rise too much, but only wants to
drain liquidity. The only option before it now looks like an at least
50 bps CRR hike on July 30," said Baljinder Singh, a bond dealer with
Andhra Bank.

The rupee, meanwhile, weakened further on Thursday and is close to
losing all of the gains made since the central bank's bold and
unexpected measures on Monday, which rattled markets and led some
economists to cut their growth forecasts for Asia's third-largest
economy.

The currency ended at 59.67/68 to the dollar, from a previous close of
59.34/35. It hit an all-time low of 61.21 on July 8 as investors fret
about the current account deficit and a lack of structural reforms in
an economy growing at a decade low of 5 per cent.

Government bond yields eased on Thursday after the RBI's bond sale,
with the benchmark 10-year bond yield dropping 6 basis points on the
day to 7.99 per cent. Yields are still up 44 basis points from before
Monday night's measures.

The hike in short-term interest has virtually shut the market in
commercial bonds and short-term bonds used through which companies and
banks raise short-term funds.

Foreign investors sold more than $200 million in Indian debt and
stocks on Tuesday and Wednesday. Indian stocks gained about 1 per cent
on Thursday.

Copyright: Thomson Reuters 2013