RBI's move post Union Budget. What Next? will it support the Govt to meet its Fiscal need.

RBI's move post Union Budget. What Next? will it support the Govt to meet its Fiscal need.

The RBI has been buying dollars by the truckload. Forex reserves have been going up substantially. Since Feb 2015 it has been consistently above 325 Billion dollars and has even touched record high of 355 Billion as well; this is the highest ever Forex reserve India has ever held.

The government has been holding a high cash balance with RBI, which is seen as one of key reasons for liquidity tightness in the system. It was as high as Rs 1.40 lakh crore a few weeks ago and is still hovering at around Rs 1 lakh crore. The expected excess supply is leading to yield spikes, which can be offset by buybacks.

So far this financial year, RBI has conducted open market operations (purchase) to the tune of Rs 10,000 crore net of OMO sales versus Rs 35,380 crore bought back by the government directly. 

Infect, corporate's like to raise funds via sale of bonds, which are priced in proportion to sovereign yields. While corporate borrowing costs are going up inch by inch, the government is also paying higher costs at the expense of tax payers money in a supposedly low interest rate regime set by RBI governor Raghuram Rajan. 

Thus the government's buybacks will result in those securities ceasing to exist on the issuer's books, creating a replacement demand for bonds, besides softening yield prices, especially for long-maturity bonds. In simplicity, the move is likely to help bring down borrowing costs for corporate as bond yields are hovering at high levels seen at the beginning of last year, despite the central bank slashing borrowing costs by 125 basis points cumulatively in the past 14 months. 

Besides G-Secs, UDAY bonds (a bailout scheme for state power distribution companies) and state government bonds together are expected to add around Rs 3.20 lakh crore collectively till March-end. Next year it could be Rs 3.30 lakh crore. 

Bottom line is although this can generate replacement demand for bonds, the money will again go back to where it was (once the government starts borrowing in the new fiscal year).

Hence its imperative for the Government to stick to 3.9% or lower fiscal deficit projections. Thus can we expect a interest rate cut from RBI's governor Raghuram Rajan as early as March 2016.

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