(Reuters) - The Reserve Bank of India's liquidity management operations are unrelated to exchange rate movements, a deputy governor said on Wednesday, following speculation that the bank could buy bonds less frequently as a weak rupee began to show signs of recovery.
To defend the rupee the RBI has been selling dollars, thereby draining rupee liquidity from the banking system, while infusing money through bond purchases commonly known as open market operations (OMO) to stop the liquidity deficit from becoming more severe.
But as the rupee steadied during the past week, speculation arose that the RBI may conduct bond purchases less often.
Subir Gokarn, the deputy governor responsible for monetary policy, warned against making such assumptions.
"I don't think you can directly correlate the rupee movement with the OMOs," Gokarn on sidelines of an industry event in Chennai, where the RBI's two-day board meeting began on Wednesday.
"OMOs are being driven by judgements about liquidity conditions and they will continue to be driven by judgements about liquidity conditions, whatever is causing liquidity stress, whether it is foreign exchange market or something else."
Bond yields moved up by around 3 basis points last week after no OMO announcement, but since then market has been pricing in fewer OMOs due the rupee's recovery, and yields have declined partly on expectations that a debt auction will draw inflows from foreign investors.
The rupee rose 5.1 percent through four trading sessions until Tuesday in line with regional peers but weakened about 0.3 percent on Wednesday to 54.55 to the dollar.
Gokarn's comments had no market impact on Wednesday, as traders saw little chance if OMOs this week.
Going forward , traders said, the RBI is likely to buy less debt because the liquidity squeeze in the banking system appears to have eased.
"There is less chance of an OMO because the liquidity situation has stabilised," said Ashish Vaidya, executive director and head of trading at UBS in Mumbai.
"Obviously, the rupee has corrected, and the RBI is not going to suck rupee liquidity from the banking system," he said.
Banks borrowed 483.65 billion rupees from the RBI's liquidity adjustment facility on Wednesday, significantly less than the 97 9.15 billion rupees borrowed in the previous session.
The RBI had last bought debt on June 22, when banks borrowed 1.06 trillion rupees from the central bank.
Since the fiscal year began in April, the RBI has bought 591.01 bln rupees of bonds, compared with a notified amount of 700 bln rupees.
Gokarn added that a high current account deficit has also weighed on the rupee and any reduction in the deficit will help the rupee recover and stabilise.
India's external balance deteriorated sharply in the January-March quarter, with the current account deficit touching a record high of 4.5 percent of GDP and the balance of payments stuck in the red for the second straight quarter. (Writing by Suvashree Dey Choudhury, additional reporting by Swati Bhat; Editing by Simon Cameron-Moore)
