The Reserve Bank of India (RBI) has guided for a shift in policy to supporting growth from the earlier policy of containing inflation expectations.
It maintained status quo on rates in its policy review on Tuesday, even as it spelt out a shift in stance starting January 2013.
The RBI will look for a steeper yield curve going forward to support its growth bias. The current government bond yield curve is extremely flat with 1, 5, 10 and 30-year bonds trading at levels of 8%, 8.08%, 8.15% and 8.40%, respectively.
The spread between one and ten-year segment of the curve is just 15 basis points (bps), while the spread between the 10 and 30-year segments of the curve is 25 bps. Such spreads are more indicative of economic growth coming off rather than growth rising as flat spreads indicate that long term bond yields are factoring in lower growth expectations and this lower growth expectations will lead to fall in inflation.
One of the reasons for the flat spreads is the tight liquidity condition that is prevailing in the market. Liquidity as measured by the bids for repo in the liquidity adjustment facility auction of the RBI has been consistently negative for over two and half years and the system has been consistently borrowing from the RBI at repo rates.
Repo rates at 8% levels are down just 50 bps since April. Repo saw its highest levels at the beginning of this calendar year at 8.5% as RBI raised rates to fight inflation expectations.
RBI will look to steepen the yield curve by lowering repo rates starting January and by looking to get liquidity into positive territory.
Despite cash reserve ratio cuts of 175 bps (infusing `1.4 lakh crore) over the last one year and bond purchases of over `100,000 crore this fiscal, liquidity is sparse.
The focus on growth will involve raising credit growth estimates for 2013-14. However, for credit to grow bank deposits have to grow. They have been lagging over the last two months, leading to the incremental credit deposit ratio rising to 76% from 20%. The RBI will have to fix this through liquidity infusion.
Doing all that will lower short-term yields, which, in turn, will help lower lending costs for banks.
The corporate bond yield curve, too, will steepen on the back of RBI growth policy. One-year, five-year and ten-year corporate bonds are trading at levels of 8.75%, 8.95% and 9%, respectively, and levels on one and five-year corporate bonds should fall faster than levels on the ten-year corporate bond, leading to the yield curve steepening.