UPDATE 1-Indian bonds soar, rupee still weak after RBI cash steps

Wed Aug 21, 2013 12:56am EDT

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By Subhadip Sircar and Swati Bhat

MUMBAI Aug 21 (Reuters) - Indian government bonds were headed for their biggest gain in at least 15 years, while the rupee remained under pressure on Wednesday after the Reserve Bank of India (RBI) said it will buy bonds to ease a cash crunch, and relaxed bond holding rules for lenders.

Yield on the benchmark 10-year bond fell as much as 69 basis points to 8.21 percent as its price rose. It was last trading at 8.28 percent and headed for its biggest single day fall since at least 1998.

Beaten-down bank stocks rallied as the central bank relaxed some bond holding rules for lenders. State Bank of India was up 5.2 percent, while ICICI Bank was 3.8 percent up. The benchmark Sensex was 1 pct higher.

Bond yields had risen 135 basis points as of Tuesday's close since the RBI first started tightening market cash conditions in mid-July, adopting a strategy of raising short-term rates to keep rupee speculators at bay.

Those measures have failed to help the rupee, down 5.3 percent since the central bank's first steps, but have instead battered bonds, pushing up yields and raising borrowing costs for companies as banks raised lending rates.

"The decision to wade into government bond markets is interesting, and shows the difficulty that India has in calibrating a monetary policy mix aimed at supporting the rupee, but not choking off economic growth," Sacha Tihanyi, senior currency strategist at Scotiabank wrote in a note.

The RBI said late on Tuesday it will buy 80 billion rupees ($1.26 billion) of bonds on Friday and will pare down its cash management bill sales as its target of pushing up the overnight rate to the central bank's emergency funding rate of 10.25 percent had been achieved.

The RBI relaxed rules on mandatory bond holdings for banks, known as the statutory liquidity ratio, which will help protect lenders from large mark-to-market losses. While banks had previously been asked to cut their hold-to-maturity bond holdings gradually to 23 percent of deposits, the RBI on Tuesday allowed banks to retain them at 24.5 percent of deposits.

Still, the rupee remained under pressure despite the stock and bond market rallies. The rupee was at 63.29/30 versus Tuesday's close of 63.25/26. On Tuesday, it breached the 64 level for the first time ever before the central bank stepped in and sold dollars.

Deutsche Bank in a note on Wednesday said that the rupee may slide to 70 to the dollar in a month or so, although some revival is expected by the end of the year.

Interest rate swaps were also sharply down. The 5-year OIS was down 49 basis points at 8.46 percent, while the 1-year was down 44 bps at 9.45 pct. ($1 = 63.5550 Indian rupees) (Additional reporting Archana Narayanan; Editing by Tony Munroe and Eric Meijer)

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