RBI’s priority is liquidity management and it will continue to use OMO (Open Market Operation) to infuse liquidity into the system. RBI has purchased government bonds worth Rs 67,000 crores April 2012 to date and it has signaled that it will but more government bonds in order to keep system liquidity comfortable. Liquidity as measured by bids for repo in the LAF (Liquidity Adjustment Facility) has been in a Rs 80,000 crores to Rs 90,000 crores deficit over the last three weeks, and with RBI buying more bonds to infuse liquidity, this deficit is expected to come off down the line.
RBI’s focus on liquidity will help government bond yields trend down. The bond market was worried about absorbing a huge government bond supply that is averaging Rs 15,000 crores every week and ten year benchmark bond yields reflected that concern and was trading at levels of 8.7% in the beginning of April. RBI buying of bonds has helped ease supply fears and the ten year benchmark bond the 8.15% 2022 bond is trading at around 8.15% levels, down 55bps from highs.
Government bond yields will trend down below 8% levels in the coming weeks as the market gets comfort from the presence of RBI in the market. Bond yields will trend significantly below 8% if the market starts expecting repo rate cuts in its July policy review. The fact that RBI refrained from cutting rates in today’s policy review will help markets to price in rate cut expectations in July, which is better than pricing in a rate cut that has already happened.
RBI held policy rates of CRR (Cash Reserve Ratio) and Repo status quo in its policy review today. The markets were expecting a 25bps repo rate cut and the no change policy stance by the RBI has seen some rate cut positions being unwound. The Sensex and Nifty have fallen by over 1% while ten year bond yields have risen by 8bps post policy.
RBI held back rate cuts this policy citing inflation at levels of 7.55%, up from 6.9% seen in January 2012. The fact that RBI had cut repo rates by 50bps in its April policy to address growth concerns of GDP and IIP, whose growth came in at 5.3% for fourth quarter 2011-12 and 0.1% for April 2012 respectively played a part in RBI maintaining policy rates in June’s policy.
RBI’s infusion of liquidity through CRR cuts and bond purchases has made its monetary stance more accommodative and it did not have to cut rates to reinforce its stance of helping growth with price stability. RBI has infused liquidity worth Rs 135,000 through government bond purchases since the beginning of calendar 2012 of which Rs 67,000 crores have been in the new fiscal 2012-13. RBI’s CRR cut of 125bps since January 2012 has infused Rs 80,000 crores into the system. Total liquidity infusion through government bond purchases plus CRR cuts in the first six months of 2012 is Rs 215,000 crores. RBI has been lending around Rs 80,000 crores to Rs 90,000 crores on a daily basis to the system through the LAF (Liquidity Adjustment Facility) window, adding on to the system liquidity infusion.
The increase in limit of export credit refinance of banks from 15% of outstanding export credit to 50% of outstanding export credit is likely to release Rs 30,000 crores into the system, which is equivalent to a 50 bps CRR cut. RBI’s medium term CRR target is 3% and it will look to cut CRR when it believes that inflation is coming off and staying down.
