RBI will cut the Repo Rate by 25bps this week as it recognizes government’s commitment to lowering fiscal deficit, easing inflation expectations, Fed going slow on rate hikes and global growth concerns. Read our analysis Ten Year Bond Yield to Trend down to 7% for analysis on factors going into rate cuts.
There are expectations of 50bps rate cut in some sections of the market but RBI will stick to 25bps rate cut with accommodative policy guidance largely to encourage portfolio flows given that there is an impending outflow of USD 34 billion on FCNR B deposits later this year. Read our analysis on FCNR B deposit scheme in 2013. RBI will also be concerned on the slow pace of bank deposit growth and big bang rate cuts could slow down deposit growth even further.
RBI lent a record Rs 3300 billion to banks to tide them over a fiscal year end fund crunch. Bond markets overlooked the liquidity tightness to take down bond yields on expectations of Repo Rate cut in RBI’s policy statement on the 5th of April.
System liquidity as measured by bids for Repo, Reverse Repo, Term Repo and Term Reverse Repo in the LAF (Liquidity Adjustment Facility) auctions of the RBI and drawdown from Standing Facilities (MSF or Marginal Standing Facility and Export Credit Refinance) was in deficit of Rs 3300 billion as of 1st April. The deficit was Rs 2384 billion in the week previous to last. Government surplus was at levels of Rs 1516 billion last week, lower by Rs 200 billion week on week.
Banks have seen the slowest deposit growth in fiscal 2015-16 since 1962-63 and Incremental Credit Deposit Ratio (ICDR) at 87% as of 18th March 2016 has resulted in a fund crunch for the system. Watch our Two Minute Concept Video on ICDR explanation.
RBI will be addressing the issue of slowdown in deposit growth in its policy statement on the 5th of April. Banks have considerably slowed down growth in investments from 13% levels to around 6% levels over the last one year and this has implications for government borrowing as well. Read our Report on Bank Demand Side Equation Explained for analysis of Banks participation in Government Borrowing.
Government bond markets saw yields closing down and yield curve steepening last week on rate cut expectations. The benchmark ten year bond, the 7.59% 2026 bond saw yields closing down by 5bps at 7.46% levels. The 8.27% 2020 bond saw yields falling by 15bps to close at 7.41% levels. The 7.88% 2030 bond saw yields falling by 6bps to close at 7.82% levels while the 8.13% 2045 bond saw yields falling by 2bps to close at 7.91% levels. Government bond yields are likely to trend down on April RBI rate cuts.
OIS market saw one year and five year OIS yields close down week on week with the one over five OIS spread flattening out. One year OIS yield fell 18bps while five year OIS yield fell 7bps to close at 6.70% and 6.61% respectively. OIS yields are likely to fall on expectations of liquidity easing out and RBI rate cut.
Benchmark AAA corporate bond yields fell last week on easing liquidity and rate cut expectations. Three year bond yields fell 7bps to close at 7.96% levels with spreads up by 4bps at 47bps levels. Five year bond yields were down 5bps at 8.15% with spreads up by 10bps at 60bps levels while ten year bond yields were down 5bps at 8.28% with spreads flat at 68bps levels. Corporate bond yield and spread curve will fall as market searches for yields amidst accommodative monetary policy.