Under OMO, the central bank buys or sells government bonds (G-Secs) to pump or withdraw liquidity from the system, depending on the situation. In the case of OMO sales, RBI would sell G-Secs in the market and raise money. Fearing an oversupply of G-Secs, prices of these bonds fell on Friday and yields rose. This happened despite the governor making it clear that he could resort to OMO sales only to manage liquidity and not to generate returns.
However, the bond market thought differently. The yield spread between US and Indian 10-year G-Secs has fallen to historically low levels, according to economists and bond traders. This could have a negative impact on the strength of the rupee as the rupee-dollar exchange rate is near an all-time low.
In the forex market, the rupee closed virtually unchanged at 83.25 against the dollar on Friday. However, market players expect some volatility in the coming week.
“The average 20-year return differential between India and the US is 460 basis points. Last year the average was 360 basis points, while currently it is lower than 250 basis points. This could be a cause of concern for the RBI as it has not hiked the policy rate this time. OMOs by RBI could help prevent the interest rate differential from narrowing further,” said a bond trader.
A recent report from Emkay global financial services had noted that the expected resumption of an upward trend in dollar and US Treasury yields would require significant shock repricing of higher rates outside the US. “The interest rate spread between emerging Asia/India and developed countries has reached unprecedented levels, raising renewed concerns about further volatility in the future,” the report said.
In the stock market, the reaction to the RBI’s decision to maintain the status quo on interest rates led to a rally, albeit with a delay. The sensex was initially unchanged but rallied 364 points in the late session to close at 65,996. Bajaj Finance, Infosys and ITC contributed the most to the index’s gains, BSE data showed.
