Why in News?
India’s 10-year government bond yield rose only 8 basis points in six months, compared with much larger increases in major advanced and emerging economies. The RBI relied more on foreign exchange and liquidity management than policy-rate hikes.
Key Concepts
1. FCNR(B) Deposits
- FCNR(B) = Foreign Currency Non-Resident (Bank) deposits.
- Term deposits held by NRIs in permitted foreign currencies.
- Principal and interest are repaid in the same foreign currency, protecting depositors from exchange-rate risk.
- Banks can bring these foreign currency funds into India and swap them with the RBI.
- This increases forex reserves and rupee liquidity.
- It is a borrowed inflow with fixed maturity, not permanent capital.
2. 10-Year Benchmark Bond Yield
- Return earned on the most actively traded 10-year government security.
- Bond price and yield move inversely:
- Bond price ↓ → Yield ↑
- Bond price ↑ → Yield ↓
- It influences pricing of corporate bonds and long-term loans.
- 1 basis point = 0.01 percentage point.
3. RBI’s Policy Corridor
The overnight money-market rate operates within a corridor around the repo rate.
- MSF → Upper ceiling; banks borrow from RBI.
- SDF → Lower floor; banks park surplus funds with RBI.
- The corridor is 25 basis points on either side of the repo rate.
4. Certificate of Deposit
- A short-tenor negotiable money-market instrument issued by banks to raise funds.
- Rising CD issuance can indicate credit growth exceeding deposit growth.
- Falling issuance suggests deposits are sufficient to finance lending.
5. Bloomberg Global Aggregate Index
- A global benchmark bond index tracked by passive funds.
- Inclusion of Indian government bonds would lead index-tracking funds to purchase Indian bonds.
- India’s inclusion was deferred, postponing potential index-driven inflows.
What Did the RBI Do?
- Instead of aggressively raising the policy rate, the RBI used targeted measures to attract foreign currency:
- FCNR(B) deposits
- External Commercial Borrowings
- Overseas foreign-currency borrowings
- These measures attracted about $56.8 billion between 8 June and 13 August, with $52.3 billion through FCNR(B).
Impact on Banking Liquidity
- Overnight rates moved below the repo rate towards the SDF floor.
- Deposits increased.
- Banks relied less on market borrowing.
- Certificate of Deposit issuance declined.
- Banking-system surplus liquidity increased.
“[2022] With reference to the Indian economy, consider the following statements:
1. If the inflation is too high, Reserve Bank of India (RBI) is likely to buy government securities.
2. If the rupee is rapidly depreciating, RBI is likely to sell dollars in the market.
3. If interest rates in the USA or European Union were to fall, that is likely to induce RBI to buy dollars.
Which of the statements given above are correct?
(a) 1 and 2 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2 and 3
