State Bank of India (SBI) is likely to sell big chunk of gilts to the RBI in a one-to-one deal to raise resources to redeem its India Millennium Deposits, scheduled on December 29, 2005. RBI is said to be exploring this option if liquidity conditions warrant. Market players expect SBI to surrender bonds issued under the Market Stabilisation Scheme (MSS) -- a RBI programme aimed at impounding surplus liquidity.

RBI had issued two securities — the 4.83% ’06 bond and the 11.90% ’07 bond under MSS. The outstanding amount under these bonds is said to be over Rs. 10,000 crore. Unlike regular G-secs, the MSS bonds aren’t used to fund the country’s fiscal deficit but are used to absorb surplus liquidity generated from foreign inflows.

The IMD redemption may involve a payout above $5bn net of reinvestment in local schemes. The market expectation is that reinvestment may not be that high as investors are cautious about betting on the future of the rupee. Even if local banks manage to retain a couple of billion dollars, SBI will still have to pay out over $5bn. SBI has already raised part of the rupee resources that it needs to buy this $5bn from RBI.

The forex supply isn’t a problem since it is RBI, with reserves of $144bn, that will be providing the dollars. In preparation for the redemption, SBI has invested in bonds with maturities that are almost co-terminus with the IMD maturity.

But after witnessing the tightening of the markets during Diwali, the central bank does not want SBI to cause an upheaval by dumping bonds. Liquidity had first tightened in November immediately after Diwali, when RBI for the first time in 11 months turned a lender to the banking system. Although the situation improved in early December the position has worsened again due to advance tax outlflows. Call rates have slipped back into the 6.25%-6.35% range with RBI again becoming a lender. 

(The Economic Times)