Bond Yields have fallen sharply and fixed-income funds have posted strong gains after the Reserve Bank appeared to reverse the liquidity-tightening course that it had set on some weeks ago in a now-failed defence of the rupee. Yesterday, a number of fixed-income mutual funds posted gains as high as 2 per cent. A large number of funds had gains of more than 1 per cent.
The liquidity took the form of bond buying that injected Rs 8,000 crore into the system late yesterday. More than the actual amount, the signal that the central bank has reversed course was more important for the bond markets. This reversal in the RBI’s stance bodes well not just for stunned bond fund investors but also for the equity markets. It shows that the RBI has now admitted that the earlier measures haven’t worked to defend the rupee and have caused far too much collateral damage to other parts of the financial markets. Falling bonds were doing major damage to bank’s already strained balance sheets by way of large losses in their holdings.
Even though Governor Subbarao is still the chief central banker, Raghuram Rajan has joined the RBI as an ‘Office on Special Duty’. It’s now clear that the special duty involves carrying the finance minister’s growth-above-all message to Mumbai. Says the RBI press release: ‘It is important to address the risks to macroeconomic stability from external sector imbalances. At the same time, it is also important to ensure that the liquidity tightening does not harden longer term yields sharply and adversely impact the flow of credit to the productive sectors of the economy.’
Technically speaking, the liquidity easing should lead to an even further weakening of the rupee. However, the underlying message--that the government is serious about growth points in the opposite direction. How seriously the markets take this message will be seen over the next few days.