RBI's Buyback Operation: Why It Missed The Mark On Liquidity Relief

In a buyback, the government uses its cash reserves to repay a portion of its outstanding borrowings through bonds before maturity. Since banks hold large amounts of government bonds, buyback operations inject liquidity into the banking system.

Despite a lukewarm response to the last three buyback auctions, the Reserve Bank of India announced another operation for Rs 40,000 crore on Monday. The government offered to buy back four securities—one maturing next month, one in July, and two in five months.

Although system liquidity eased to Rs 2 lakh crore in May, the RBI has managed liquidity stress through variable rate repo auctions, according to Mayank Prakash, deputy head of fixed income at Baroda BNP Paribas.

Following the RBI's dividend payout of Rs 2.11 lakh crore for FY24, the government's cash balances with the central bank stand at about Rs 5 lakh crore, according to market estimates.

The central bank faces a trilemma: lowering the government's borrowing costs, ensuring sufficient liquidity in the financial system, and not signaling any future rate action, bond market experts said.

"The government cannot spend from its coffers at this point in time due to a model code of conduct. The maturities are due anyway in the next few months, so the intent is to make use of this money and make an early redemption," Prakash said.

The pricing of government securities in the RBI's buyback operations has been a point of contention between the RBI and banks, bond traders said.

Excluding the latest Rs 40,000 crore buyback, the RBI has conducted auctions to buy government bonds worth Rs 1.6 lakh crore this month alone. However, it only garnered offers worth Rs 1.1 lakh crore. Out of this, the RBI accepted offers amounting to Rs 17,849 crore, which is 11% of the total bonds offered for repurchase.

In the first two buybacks, the bond mix included those that were due for maturity in November and January. The central bank then changed the mix of securities, seemingly in the hope of better pricing offers, according to Abhishek Upadhyay, senior economist at ICICI Securities Primary dealership.

Banks may have bought the securities offered at the auction earlier at higher prices, and they might not want to sell them at a loss, bond market traders said.

"Lots of these securities must be lying in the held-to-maturity, or HTM, books of banks... that limits their participation. Therefore, the choice of securities becomes crucial," Upadhyay said.

Traders expect a muted response in the upcoming repurchase operation, as they exercise caution ahead of crucial events in the coming days. The election outcome on June 4, the upcoming final Union Budget in July, as well as foreign fund inflows on account of JP Morgan bond index inclusion, are cues to watch out for, bond traders said.