Banking Liquidity Likely To Be In Deficit For Next Two Months, Says Nomura

Outlook on the banking system liquidity remains bleak as it is expected to be in deficit for the next two months since the rupee's liquidity has tightened significantly due to the Reserve Bank of India's foreign exchange interventions and outflows in cash in circulation, Nomura Group said.

"...given we are past the large bond redemptions and as CIC outflows are likely to persist in Q1, we expect the banking market to be in deficit for the next two months," the global brokerage firm said in a report.

The central bank needs to be more proactive and believes that buy or sell swaps should be undertaken to inject rupee liquidity and lower rupee premia, according to Nomura. Further cuts in cash reserve ratio can't be ruled out, and open market operation purchases are becoming more likely.

"In our view, OMO purchases are becoming more likely. Again, while this would not solve the problem, it would extend a helping hand. We will continue to watch the weekly data for more signs of RBI action," Nomura said.

The liquidity tightness is a result of higher rupee-implied rates in the short-dated FX swap market are diverting rupee liquidity from the call market.

Mumbai Inter-Bank Offered Rate, also known as MIBOR, has also risen, breaching the previous 6.85% level and printing at or above 7.00%.

Given the RBI is absent from liquidity action, Nomura expects the MIBOR to stay elevated around 6.90 to 7.00% in the coming weeks.

While the government spending towards month-end could provide some temporary relief, it would likely be short-lived.

Therefore, Nomura expects OMO purchases to support the Indian government bond yield curve position.

Lastly, there has been a lot of speculation on the replacement of Deputy Governor Michael Patra, as his term will end next week. The brokerage will closely watch RBI's actions next week for any hint of a change in strategy.