As banks now have extra money to invest after the withdrawal of the country's highest-value currency note, India's sagging bond market could find fresh life.
According to QuantEco Research and Kotak Mahindra Bank Ltd., the removal of 2,000 rupee notes from circulation may result in an increase in the value of the Indian rupee of up to 1 trillion rupees ($12.1 billion). Consumers can deposit the notes into their bank accounts or trade them in for other denominations until the end of September.
As some of the notes return as deposits, Pankaj Pathak, fixed-income fund manager at Quantum Asset Management Co., predicted that shorter papers and bonds will profit.
A rise in rupee government bonds may be revived by the liquidity injection after it stalled last week because the central bank's dividend payment to the government fell short of traders' expectations. The Finance Ministry might have decreased its bond sales and lowered borrowing costs with a larger payment.
The benchmark 10-year sovereign yield has increased to 7.01% after falling to 6.94% last week, the lowest level in more than a year, on speculation that India's tightening cycle may be coming to an end. In November 2016, the yield decreased by 55 basis points as a result of a move by the government to remove practically all currency from circulation.
The Reserve Bank of India constantly watches the weighted average call rate, which has consistently maintained above the policy rate over the previous month and has even over the 6.75% threshold for emergency funding.
Due to a greater deposit base, the decision to withdraw the note "will probably result in a temporary spurt in system liquidity," Madhavi Arora, lead economist at Emkay Global Financial Services, wrote in a note. "In the near term, we expect the bond curve to steepen while the forward premium will continue to decline, placing pressure on the rupee."
QuantEco expects that the bond market's rise will pass quickly. According to a letter from the RBI, market expectations of the central bank injecting liquidity through open market purchases in the second half of the fiscal year will diminish because banks' holdings of fixed-income assets currently exceed regulatory limitations.
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