India’s largest asset management firm is advocating for the federal budget to equip the Reserve Bank of India (RBI) with a crucial liquidity management tool amid anticipated bond market inflows following the nation’s inclusion in a prominent global index.
Rajeev Radhakrishnan, Chief Investment Officer for Fixed Income at SBI Funds Management Ltd., emphasized the need for the central bank to employ Market Stabilization Scheme (MSS) bonds to manage potential surges in liquidity. “Issuing short-term government securities would be a more effective approach than selling long-term bonds, which can distort the market,” Radhakrishnan said. “The market stabilization scheme is a proven tool, and its inclusion in this budget would be prudent.”
MSS bonds, which are issued outside the regular borrowing program, are intended to help the RBI absorb excess liquidity. The funds raised from these bonds are placed in a separate account and are not used for government expenditures. With India’s bond market set to see increased inflows following its inclusion in JPMorgan Chase & Co.’s emerging-market index, the use of MSS bonds is under scrutiny.
Despite Radhakrishnan’s position, most analysts surveyed by Bloomberg prior to the July 23 budget announcement do not anticipate the introduction of MSS bonds. The RBI has been managing liquidity through variable rate reverse repo auctions, which involve short-term parking of funds with the central bank. Some experts believe these measures are currently adequate.
The RBI also employs other tools, such as open market operations, which involve buying and selling bonds in the secondary market to regulate liquidity. JPMorgan projects that India will experience around $25 billion in bond inflows over the next ten months, following the index inclusion, with approximately $12 billion already received since the announcement in September.
In July, India’s banking system saw a liquidity surplus of about 1.4 trillion rupees ($16.7 billion), a shift from the previous deficit experienced throughout the year due to the RBI’s stringent measures to control inflation.
Historically, MSS bonds have been utilized in India during periods of significant liquidity changes, such as following the 2016 currency ban and in response to the 2008 global financial crisis.
As India’s bond market gains increased foreign investment and enters more global indices, Radhakrishnan advocates for the RBI to be prepared with the right tools to manage future challenges. “The macroeconomic environment is improving, and the central bank should be equipped with the appropriate instruments,” he stated.
