Comment

The Reserve Bank of India’s move on April 17 to hike cash reserve ratio by 50bps will suck out around Rs 18,500 crore of liquidity from the system. The CRR hike is effective in two tranches, from April 26 and May 10, or 25 basis points each.

RBI cited controlling inflationary expectations, which are elevated at present for the CRR hike, as the reason for the hike.

Inflation as measured by the wholesale price index (WPI) was at 7.14% for the week ended April 5, 2008.

Inflation has been trending way over RBI’s target rate of 5% to 5.5%, touching a high of 7.41% for the week ended March 29, 2008.

RBI has been hawkish on inflation and has hinted at policy actions in its annual monetary policy for 2008-09, which will be presented on April 29.

The suddenness of the CRR cut has taken the market by surprise.
RBI has been saying that it will take actions to control inflation expectations in the annual policy. RBI started sucking out liquidity through issuance of MSS (market stabilisation scheme) treasury bills and bonds and government bonds under the regular government borrowing programme.

RBI issued Rs 23,000 crore worth securities in the week before last and Rs 11,500 crore worth securities last week. The apex bank also rejected bids for securities worth Rs 5,000 crore of the Rs 11,500 crore issued last week.

The rejection of the bids in the treasury bills auction confused the market. RBI, almost at the same time, also announced the auction of Rs 10,000 crore dated government bond under the regular borrowing programme. The auction will be held today.

RBI traditionally holds auctions of government bond on Fridays and the shift to Monday came as another surprise.

The CRR hike comes against confusing signals from the RBI and the market reaction to the hike will be keenly watched. The market may heave a sigh of relief that RBI has finally taken a measure or it may remain nervous till the monetary policy on April 29 on expectations of hikes in benchmark rates.

Liquidity came off from higher levels on auction outflows. Liquidity, as measured by bids for reverse repo in the LAF (liquidity adjustment facility) of the RBI, saw bids for reverse repo at 6% coming off from over Rs 30,000 crore to Rs 7,000 crore.

Overnight rates moved up from 5% to 5.5% levels to around 6%. Liquidity is expected to get tighter on auctions and CRR hike and overnight rates will trend higher.

Government bonds
Government bonds saw yields move up week on week. Yield on the benchmark 10-year bond 7.99% 2017 bond closed higher by 10 bps at 8.12% levels.

Five-year benchmark bond yields was higher by 2 bps with the yield on the 7.27% 2013 bond closing at 8.02% levels. Yields on the long bond, the 8.33% 2036, closed flat at 8.63% levels.

The ten-over-thirty spread closed lower by 10bps at 51bps levels. The auction of 6.57% 2011 bond for Rs 3,000 crore under MSS saw the cut-off at 8.08% levels against 7.95% in the previous week. RBI will auction government bonds worth Rs 10,000 crore under the government borrowing programme today.

RBI is issuing a 10-year bond for Rs 6,000 crore under a yield-based auction and reissuing 8.33% 2036 bond for Rs 4,000 crore under a price-based auction. The auction cut-off will be of interest given the CRR hike and the monetary policy on the April 29.

Treasury bills, corporate bonds and overnight index swaps
Treasury bills (T-bills) yields were higher last week on increased supply. The cut-off on the 91-day T-bill auction held on April 16 came in at 7.44% against a cut off of 7.23% in the previous auction.

The 182-day T-bill auction saw the cut-off coming in at 7.60% against a 7.19% cut-off in the previous auction. RBI rejected bids worth Rs 2,500 crore in the 91-day and 182-day T-bill auction.

Corporate bonds saw yields move up across the curve as cut-offs of government papers came in negative. Five-year yields were trading in the 9.55% to 9.60% range, up 10bps week on week.

Five-year AAA bond spreads were higher by 4bps week on week at 144 bps levels as liquidity came off. Corporate bond spreads are likely to rise on CRR hike and government bond auctions.

Overnight index swaps (OIS) saw the swap curve rise on liquidity and interest rate concerns. One-year OIS yields moved up by 6bps to close last week at 7.36%% levels while the five-year OIS yields closed higher by 4bps at 7.46% levels.

The one-over-five spread flattened by 2bps from 12bps levels to 10bps levels. OIS yields are likely to remain under pressure on interest rate uncertainty.

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.