The Reserve Bank of India’s unexpected decision to shut its dollar deposit scheme earlier than planned has increased short-term bond yields and tightened rupee liquidity, raising questions about the country’s forex reserves and future policy stance.
India’s bond market came under pressure after the Reserve Bank of India shut its dollar deposit window earlier than planned, a move that traders said tightened near-term rupee liquidity and pushed short-dated government bond yields higher. Bloomberg reported that the decision surprised markets because RBI governor Sanjay Malhotra had said as recently as the August 5 monetary policy meeting that an early closure was not under consideration.
The steepest reaction was in the shorter end of the curve. The five-year yield rose by as much as 9 basis points to 6.44%, while the 10-year yield climbed 4 basis points to 6.80%, according to market data cited by Bloomberg. Gopal Tripathi, treasury head at Jana Small Finance Bank, told Bloomberg that ending the scheme a month sooner than expected could leave the market with less liquidity than participants had been counting on.
The dollar deposit facility had helped draw in more than $50bn, bolstering foreign exchange reserves and easing pressure on domestic money markets. Bloomberg said India’s reserves rose by more than $30bn in the past three weeks to about $707bn. But analysts warned that the faster-than-expected shutdown could slow further reserve gains and reduce support for the rupee, which has recently benefited from stronger inflows.
Nomura economists said the central bank may have weighed the cost against the benefit of keeping the window open. Because the funds are borrowed and typically run for three to five years, the scheme creates future liabilities, while RBI also bears the expense of forward-premium hedging. Samiran Chakraborty, Citi’s chief India economist, said the programme was not primarily designed as a tool for rapid rupee appreciation, and Citi now expects total inflows from the facility of about $70bn, roughly $10bn less than its earlier forecast. The IMF has previously noted that RBI has relied on liquidity tools such as open market operations and forex swaps to stabilise bond markets and support financial functioning during periods of stress.
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