(Bloomberg) — India’s flagging bond rally may get a new lease of life as a withdrawal of the nation’s highest value currency note leaves banks with surplus cash to invest.
As much as 1 trillion rupees ($12.1 billion) may be added to India’s financial system as authorities remove 2,000 rupee notes from circulation, according to QuantEco Research and Kotak Mahindra Bank Ltd. Consumers have until end-September to deposit the notes into their bank accounts or exchange them for other denominations.
“Shorter papers and bonds are likely to benefit as some of the notes come back as deposits,” said Pankaj Pathak, fixed-income fund manager at Quantum Asset Management Co.
The liquidity injection may revive a rally in rupee government bonds, which lost momentum last week after the central bank’s dividend payout to the government fell short of traders’ expectations. A bigger payment would have enabled the Finance Ministry to cut its bond sales and lower borrowing costs.
Benchmark 10-year sovereign yields have climbed to 7.01% after plummeting to 6.94% last week, the lowest in over a year on bets that India’s tightening cycle may be over. The yield slid 55 basis points in November 2016 following a move by authorities to withdraw almost all cash from circulation.
The weighted average call rate, which the Reserve Bank of India closely monitors, has held above the policy rate for most of the past month and even breached the emergency funding rate of 6.75% on some days.
“The move to withdraw the note will likely result in a temporary spurt in system liquidity owing to a higher deposit base,” Madhavi Arora, lead economist at Emkay Global Financial Services, wrote in a note. “We expect the bond curve to steepen in the near term, while forward premium will decrease further, putting pressure on the rupee.”
However, QuantEco expects the boost to the bond market to be short-lived. Banks’ holdings of fixed-income assets already exceed regulatory requirements and market expectations of the RBI injecting liquidity via open market purchases in the fiscal second half will fade, it said in a note.
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