RBI disappointed bond markets by just cutting the CRR (Cash Reserve Ratio) by 25bps in its policy review on the 30th of October 2012. The market was expecting at least a 25bps repo rate cut, which the RBI did not oblige. The result of the policy disappointment was an upward shift in yield curves across segments. Government bond, corporate bond and swap curves shifted up on the back of status quo on repo rates.
The bond market will take a while to get back on track for hopes of rate cuts going forward. The RBI has indicated that any monetary easing will take place only in the fourth quarter of 2012 and in the meanwhile the market has to live with three inflation data points for the months of October, November and December 2012. Economists are estimating inflation as measured by the WPI (Wholesale Price Index) to trend above September 2012 levels of 7.81% in the coming months. RBI’s end March 2012 target for inflation is 7%.
The market will also have to contend with weekly government bond auctions and fortnightly state development loan auctions as the central and state governments go through their borrowing schedule. The government has pegged fiscal deficit at 5.3% of GDP for 2012-13 (against budget estimates of 5.1% of GDP) and has indicated that it will not exceed the full year 2012-13 budgeted net borrowing of Rs 479,000 crores. The bond market does not have any positive surprises from the government in terms of its borrowing though it has no negative surprises at present. The lack of negative surprise on borrowing is not a driver for bond yields coming off.
The CRR cut of 25bps will release Rs 17,500 crores into the system. The system is drawing down around Rs 80,000 crores from the RBI for meeting its daily fund requirements. Bids for repo in the LAF (Liquidity Adjustment Facility) auction of the RBI saw bids average Rs 75,000 crores on a daily basis last week against an average of Rs 85,000 crores seen in the week before last.
Liquidity tightness could be more temporary than permanent. The government is running a positive balance of Rs 20,800 crores with the RBI and this is likely to come back into the system on the back of spending on salaries and subsidies. The festive demand for money leakage from the system in around Rs 20,000 crores over the last one month and this is also likely to stabilize once the season is over in mid November 2012. Banks have also parked around Rs 50,000 crores with mutual funds (at least 60% is in liquid funds or extremely short term income funds) indicating that this money is liquidity on call. System liquidity does not seem as bad as it looks and this will put paid to any hopes of government bond purchases by the RBI to improve liquidity.
Ten year benchmark government bond yields closed higher by 7bps week on week with the 8.15% 2022 bond yield closing at 8.20% levels. The 8.15% 2022 bond is likely to trade in a 8.15% to 8.30% range in the coming weeks on the back of rate cut disappointment.
Corporate bonds saw two, five and ten year AAA bond yields rise by 15bps, 9bps and 5bps respectively on the back of rise in government bond yields. Two year corporate bond yields will trend down from current levels of 8.85% on the back of easing liquidity concerns while five and ten year corporate bond yields will stabilize at current levels of 8.95% to 9%.
One and five year OIS (Overnight Index Swaps) yields rose 15bps and 10bps respectively week on week on the back of policy disappointment. One year OIS yields will stabilize at current levels of 7.70% while five year OIS yields will trend up from levels of 7.10%. Easing liquidity concerns will keep one year OIS yields stable while worries on inflation will take up five years OIS yields.
Government bond auction
The government auctioned Rs 13,000 crores of bonds last week. The bonds auctioned were the 8.07% 2017 bond for Rs 3000 crores, the 8.33% 2026 bond for Rs 7000 crores and the 8.97% 2030 bond for Rs 3000 crores. The cut offs came in at 8.17%, 8.31% and 8.40% levels respectively. The government is scheduled to auction Rs 13,000 crores of bonds this week. State development loans of Rs 4300 crores is scheduled to be auctioned this week.