The Reserve Bank of India (RBI) disappointed bond markets by just cutting the CRR (Cash Reserve Ratio) by 25 bps in its policy review on October 30. The market was expecting at least a 25 bps repo rate cut, which the RBI did not oblige. The result of the policy disappointment was an upward shift in yield curves across segments. Government and corporate bonds and swap curves shifted up on the back of a status quo on repo rates.
The bond market will take a while to get back on track for hopes of a rate cut, going forward. The RBI has indicated that any monetary easing will take place only in the fourth quarter of fiscal year 2013 and meanwhile, the market has to live with three inflation data points for October, November and December. Economists are estimating inflation as measured by the WPI (wholesale price index) to trend above September 2012 levels of 7.81% in coming months. The central bank’s March-end 2013 target for inflation is 7%.
The market will also have to contend with weekly government bond auctions and fortnightly state development loan auctions as the central and state governments go through their borrowing schedule. The government has pegged the fiscal deficit at 5.3% of GDP for 2012-13 (against budget estimates of 5.1% of GDP) and has indicated that it will not exceed the full year 2012-13 budgeted net borrowing of Rs479,000 crore. The bond market does not have any positive surprises from the government in terms of its borrowing though it has no negative surprises at present. The lack of negative surprise on borrowing is not a driver for bond yields coming off.
The CRR cut of 25 bps will release Rs17,500 crore into the system. The system is drawing down around Rs80,000 crore from the RBI for meeting its daily fund requirements. Bids for repo in the LAF (liquidity adjustment facility) auction of the RBI saw bids average Rs75,000 crore on a daily basis last week against an average of Rs85,000 crore in the week before last.
Liquidity tightness could be more temporary than permanent. The government is running a positive balance of Rs20,800 crore with the RBI and this is likely to come back into the system on the back of spending on salaries and subsidies. The festive demand for money leakage from the system is around Rs20,000 crore over the last one month and this is also likely to stabilise once the season is over in mid November. Banks have also parked around Rs50,000 crore with mutual funds – at least 60% is in liquid funds or extremely short-term income funds – indicating this money is liquidity on call. System liquidity does not seem as bad as it looks and this will put paid to any hopes of government bond purchases by the RBI to improve liquidity.
Ten-year benchmark government bond yields closed higher by 7bps week on week with the 8.15% 2022 bond yield closing at 8.20% levels. The 8.15% 2022 bond is likely to trade in an 8.15-8.30% range in coming weeks on the back of rate cut disappointment.
Corporate bonds saw 2-, 5- and 10-year AAA bond yields rise by 15bps, 9bps and 5bps, respectively, following an increase in government bond yields. Two-year corporate bond yields is set to trend down from current levels of 8.85% as liquidity concerns ease while 5- and 10-year corporate bond yields may stabilise at current levels of 8.95% to 9%.
One- and five-year OIS (overnight index swaps) yields rose 15bps and 10bps, respectively, week on week due to the policy disappointment. One-year OIS yields are likely to stabilise at current levels of 7.70% while those of 5-year OIS could trend up from levels of 7.10%. Receding liquidity concerns mean stability for 1-year OIS yields while worries on inflation may push up those for 5-year OIS.
Government bond auction
The government auctioned Rs13,000 crore of bonds last week, which included the 8.07% 2017 bond for Rs3,000 crore, 8.33% 2026 (Rs7,000 crore) and 8.97% 2030 (Rs3,000 crore). The cut-offs came in at 8.17%, 8.31% and 8.40%, respectively. The government is scheduled to auction Rs13,000 crore of bonds this week. State development loans of Rs4,300 crore are also scheduled to be auctioned this week.
The writer is the editor of www.investorsareidiots.com, a website for investors