Comment

RBI set to maintain status quo on rates

The bond market is facing near-term uncertainty on direction of rates. On one hand, the market has to contend with liquidity-sucking measures by the RBI and on the other, there are signs of a slowdown in credit growth which is giving rise to hopes of rates coming off in the near future.

The surge in liquidity on the back of large-scale foreign exchange flows (foreign exchange reserves have touched $250 billion, with portfolio flows crossing $4 billion, month to date) has placed the RBI on guard against inflation and asset price bubbles.

The RBI has been taking out liquidity through daily repos and issue of MSS (market stabilization scheme) bonds.

However, a further surge in flows may force the RBI to hike CRR. The current levels of the USD/INR at around Rs 39.35 levels is giving discomfort to the government and industry. This would mean heavy intervention coupled with sterilisation measures.

The slowdown in credit growth (at 21.9% levels against 30% levels last year) is also worrying the government. Banks have been lowering lending and deposit rates to counter the slowdown in credit growth. The market is expecting the RBI to maintain status quo on rates in the near term until there are signs of credit pickup.

Net to net, the market is facing a situation where the RBI may take measures to sterilise liquidity while maintaining status quo on benchmark rates. Bond yields are likely to trend higher with the curve flattening as the RBI sucks out liquidity.

Liquidity as measured by bids for reverse repo/ repo in the LAF (Liquidity Adjustment Facility) of the RBI came down over the week on the back of auction outflows. Bids for reverse repo at 6% at end of last weekwas at Rs 36,000 crore levels against over Rs 65,000 crore seen at the beginning of last week.. Call rates hovered below reverse repo rates of 6%. They are expected to remain at around 6% levels given liquidity in the system.

Government bonds
Government bond yields closed flat week on week. The yield on the benchmark 10-year bond 7.99% 2017 bond closed almost flat last week at 7.90% levels. Five-year benchmark bond yields closed flat with the yield on the 7.40% 2012 bond closing at 7.76% levels.

Yields on the long bond the 8.33% 2036 bond closed unchanged at 8.43% levels. The five over thirty segment of the curve was unchanged to close the week at 67 bps levels.

The RBI held government bond auctions under the government borrowing programme and under the MSS last week. The bonds auctioned under the government borrowing programme were the 7.99% 2017 bond for Rs 6,000 crore and the 7.95% 2032 bond for Rs4000 crore. The cutoffs came in at expectations for the 10-year bond at 7.90% while for the long bond the cut off was lower than expectations by 3 bps at 8.45%.

The MSS auction of 5.87% 2010 bonds for Rs 4,000 crore and the 11.30% 2010 bonds for Rs 4,000 crore saw the cutoffs come in at 2 bps lower than the previous auctions. The cutoffs came in at7.78% and 7.82% respectively.

This week will see the RBI auctioning bonds under the MSS. The RBI isauctioning Rs 5,000 crore each of 5.87% 2010 bonds and 11.30% 2010 bond under MSS. The increased MSS amount will see markets bidding for higher yields.

T-bills, corporate bonds and overnight index swaps
Treasury bills (T-bills) yields came off last week on the back of higher system liquidity The cutoff on the 91-day T-bill auction held on the October 11 came inat 6.98% against a cutoff of 7.14% seen in the week earlier to last.

The 364-day T-bill auction saw the cutoff coming in at 7.37% against 7.50% seen in the previous auction. The RBI is auctioning Rs 3,500 crore of 91-day and Rs 2,500 crore of 182-day T-bills this week including Rs 3,000 crore of 91-day and Rs 2,000 crore of 182-day T-bills under MSS (market stabilisation scheme)

Corporate bonds saw spreads move down as investors bought into higher spreads. The five year AAA bond yield was quoting at 9.35%-9.40% down 10bps week on week. The five year AAA spreads were lower by around 10bps at 160bps levels. Credit spreads may not sustain at current levels given the liquidity sucking measures by the RBI and increased domestic corporate borrowings.

Overnight Index Swaps (OIS) saw one year swap yields come off on higher system liquidity The one year OIS yield fell 5bps to close last week at 6.98% levels. The five year OIS yield closed flat 7.27% levels. The one over five spread closed at 28bps, higher by 5bps week on week. Swaps will look to move higher on liquidity measure by the RBI.

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.