RBI annual policy not an event risk

The Reserve Bank of India is set to unveil the annual monetary policy for the 2009-10 on the April 21, 2009. The bond market’s expectations from the policy range from caps in reverse repo absorption to cuts in policy rate.

The system is flooded with liquidity, with daily bids for reverse repo at over Rs 1,00,000 crore. The high system liquidity has led to a healthy rally in bond markets, with yields dropping across the curve. The ten-year benchmark government bond yield has come off by 30 bps week-on-week on the back of sustained buying by investors across segments. The fall in yields has been accompanied by high volumes, which has almost tripled over the last few weeks. The improved sentiments has led to good bidding interest in government bond auctions, with the last auction of 7.56% 2014 bond seeing cut-off coming in at 6.1%. This is against the cut-off of 6.8% seen in the previous auction on the April 2.

RBI policy actions are not likely to impact the markets as much as the central bank’s commitment to keeping liquidity easy in the system, keeping policy rates at all-time lows and conducting open market operation (OMO) bond purchases.

A cut in policy rates is likely to see the market steepening the yield curve as high system liquidity will force the market to buy short-dated government bonds (up to five-year maturity) rather then lending to the RBI at below 3.5% levels. However, policy rate cuts will not filter down to yields at the medium to longer end of the curve given that there is heavy supply at that end of the curve. The market will look at RBI’s commitment to lower borrowing costs for the government for bringing down longer bond yields.

The RBI will also set fiscal targets for credit growth, deposit growth, money supply and inflation. Given that the RBI is in a pro-growth mode, targets are likely to be at 24%, 20%, 18% and 3% respectively.

Inflation as measured by the wholesale price index (WPI) is close to 0% levels with the last reading on April 4, 2009 coming in at 0.18%. The index is expected to go negative in the next couple of weeks and remain so for a few months. The RBI will want inflation at higher levels given that deflation is not good for a growing economy. To bring up inflation to around 3% levels, the RBI will keep liquidity high in the system and policy rates low for a long period of time.

Other policy measures could include corporate bond repoability and lowering risk weights for real estate and consumer credit. Corporate bond repoability will be a big step for the credit markets and can potentially boost the corporate bond market which is being crowded out by government borrowing.

Liquidity, as measured by bids for reverse repo/ repo in the central bank’s liquidity adjustment facility (LAF) auction remained high with bids for reverse repo averaging Rs 1,10,000 crore. Overnight rates remained low with call rates at 3% levels and CBLO and repo rates at around 2.5% levels. Liquidity will continue to be high in the system keeping overnight rates low.

Government bonds
Government bonds yields moved down on improved market sentiments. The benchmark ten-year bond, the 6.05% 2019, saw yields lower by 30 bps week-on-week to close at 6.4% levels. The five-year benchmark bond, the 7.56% 2014, yield closed down 25 bps at 6.1% levels while the long bond, the 6.83% 2039, saw yields come off by 8 bps to close at 7.52% levels.

The Rs 12,000 crore government bond auction held last week saw the cut-off on the 7.56% 2014 security (Rs 8,000 crore) coming in at 6.15%, and on the 8.24% 2027 security (Rs 4,000 crore) coming in at 7.44%. The cut-offs were better than market expectations by around 6 bps.

The government is auctioning Rs 8,000 crore of 6.05% 2019 bond and Rs 4,000 crore of 7.50% 2034 bond this week under uniform price method. The RBI is scheduled to conduct an OMO purchase for Rs 6,000 crore this week.

Treasury bills, corporate bonds and overnight index swaps
Treasury bills (T-bill) yields were lower at the auctions last week with the cut-off on the 91-day T-bill auction held on April 15 coming in at 3.81% against a cut-off of 4.09% in the previous auction. The 182-day T-bill auction saw the cut off coming in at 4.07% against a cut off of 4.7% in the previous auction. The RBI is auctioning Rs 8,000 crore of 91-day T-bills and Rs 2,000 crore of 364-day T-bills this week.

Corporate bond yields were lower week-on-week on the back of good buying interest at absolute levels of yields. Credit spreads rose as government bond yields dropped faster than corporate bond yields. Five-year benchmark bonds traded at 7.75% levels while ten-year benchmark bonds traded at 8.5% levels. Ten-year spreads closed at 204 bps levels up almost 15 bps week-on-week while five-year spreads closed at 150 bps levels up 13 bps week-on-week. Corporate bond yields can come off sharply if RBI signals intention for corporate bond repoability.

Overnight index swaps (OIS) saw the curve rise on hedging by the market. The one-year OIS yield closed up 12 bps at 3.94% levels while the five-year OIS yield closed up 9 bps at 5.49% levels. The one over five spread flattened by 3 bps to close at 155 bps levels. The OIS curve will take its cue from RBI policy actions.

Disclaimer: The author is head - fixed income, IDFC Mutual Fund. Views are personal.