Comment

The central bankis hawkish, but is likely to maintain status quo on rates

The Reserve Bank of India has maintained a hawkish stance on inflation, liquidity flows and financial market stability in its recent comments.

However, in the forthcoming second-quarter review of the annual monetary policy for 2007-08, on October 30, the market widely expects the RBI to maintain status quo on interest rates and CRR (cash reserve ratio).

The recent policy moves by the stock market regulator, Sebi, has to an extent served to temper expectations of foreign portfolio flows into the country.

Sebi had issued a draft note on restriction of participatory notes (P-notes) to curb portfolio flows.

The policy to be operationalised next week had the effect of FIIs (foreign institutional investors) pulling money out of the Indian stock markets (over $1 billion), leading to fall in equity indices (over 8%) and a rise in the USD/INR by 1%.

In the light of Sebi’s actions, the RBI may not take any policy measures in the review, though its tone will remain hawkish.

The fall in US treasury yields with the 10-year yield falling by 24 basis points on the back of worries on the US economy are also factors in RBI policy review.

However, RBI is known to surprise markets, and the market may not build positions going into the policy.

Bond yields closed the week almost unchanged with the 10-year benchmark bond yield closing flat at 7.90% levels. This is expected to see the markets trade quiet with focus on the policy review.

The RBI has also announced government bond auctions for Rs 8,000 crore under the government borrowing programme and Rs 6,000 crore under the MSS (market stabilization scheme).

The auction cut-offs is likely to determine the market mood going into the policy review.
Liquidity as measured by bids for reverse repo/ repo in the LAF (liquidity adjustment facility) of the RBI was down on a week-on-week basis.

Bids for reverse repo at 6% at end of last week were at Rs 32,000 crore levels against over Rs 36,000 crore seen in the week before last.

Overnight rates hovered around reverse repo rates of 6%. Overnight rates are expected to remain at around 6% levels given the current liquidity in the system.

Government bonds

Government bond yields closed flat to higher on a week-on-week basis. The yield on the benchmark 10-year bond 7.99% 2017 bond closed almost unchanged at 7.90% levels.

Five-year benchmark bond yields closed higher by 3bps with the yield on the 7.40% 2012 bond closing at 7.81% levels. Yields on the long bond the 8.33% 2036 bond closed at 8.42% levels, almost flat week on week.

The five over thirty segment of the curve flattened 5bps to close the week at 61bps levels.

The RBI held government bond auctions under the MSS last week. The MSS auction of 5.87% 2010 bonds for Rs 5000 crores and the 11.30% 2010 bonds for Rs 5000 crores saw the cut offs come in higher than the previous auctions.

The cut offs came in at 7.80% for the 5.87% 2010 bond and at 7.86% for the 11.30% 2010 bond, higher by 2bps and 4bps respectively.

This week will see the RBI auctioning bonds under the government borrowing programme and under the MSS.

The RBI is auctioning Rs 4,000 crore of 7.27% 2013 and Rs 4,000 crore of 8.35% 2022 government bonds under the government borrowing programme.

The RBI is also auctioning Rs 3,000 crore each of 5.87% 2010 bond and 11.30% 2010 bond under MSS. The auction cut-offs are likely to determine the market sentiment going into the policy review.

T-bills, corporate bonds and overnight index swaps
Treasury bills (T-bills) yields were higher week on week on the back of MSS auctions.
The cut-off on the 91-day T-bill auction held on October 17 came in at 7.10% against a cut off of 6.98% seen in the week earlier to last.

The 182-day T-bill auction saw the cut off coming in at 7.45% against 7.37% seen in the previous auction. The RBI is auctioning Rs 3,500 crore of 91-day and Rs 3,000 crore of 364 day T-bills this week including Rs 3,000 crore of 91-day and Rs 2,000 crore of 364-day T-bills under MSS (market stabilisation scheme).

Corporate bonds saw yields trade flat with the five-year AAA bond yield at 9.35%-9.40% levels. The five-year AAA spreads closed at around 144 bps levels. Credit spreads are likely to take direction from RBI policy review.

Overnight index swaps (OIS) saw one-year swap yields move higher on the back of MSS issuances. The one-year OIS yield rose 6 bps to close at 7.04% levels.

The five-year OIS yield closed flat at 7.26% levels. The one over five spread closed at 22 bps, lower by 6 bps week on week. Swaps will trade at current levels going into the policy review.

The author is head, portfolio management services, Sundaram BNP Paribas AMC Ltd. The views expressed by the author are his own and need not represent the views of the organisation in which he works.