The repo rate hike of 25bps by the RBI in its policy review on the 16th of September was widely expected by the bond market and was not a factor in bond yields moving up week on week. The ten year benchmark bond, the 7.80% 2021 bond, saw yields rising by 4bps to close last week at 8.36% levels. The market is more worried on liquidity and the second half borrowing calendar to be released after the Finance Ministry and RBI meeting on the 3rd of October than RBI policy rate hikes.
Liquidity as measured by the bids for repo in the LAF (Liquidity Adjustment Facility) auction of the RBI tightened last week as banks covered on products in anticipation of a rate hike and in anticipation of advance tax outflows. Bids for repo averaged Rs 70,500 crores on a daily basis last week against an average of Rs 17,700 crores seen in the week before last. Liquidity is expected to get tighter as advance tax money flows out of the system this week. Advance tax for quarter ended 15th September 2011 is estimated at over Rs 45,000 crores.
Liquidity will be affected negatively if RBI sells USD (US Dollars) in the market to prevent the INR (Indian Rupee) from weakening. The INR has depreciated by over 8% against the USD from levels of Rs 44.10 seen in the end of July 2011. The global risk aversion on the back of Eurozone sovereign debt worries drove the INR down and RBI had to sell nominal amounts of USD at Rs 48 to the Dollar to prevent the INR from sliding further. USD selling impacts liquidity on the negative side as it sucks out INR from the system. A further weakening of the INR may force the RBI to intervene more in the markets leading to liquidity concerns.
Liquidity and rate hike issues inverted the five over one OIS (Overnight Index Swap) curve with the spread inverting by 16bps to close the week at 98bps levels. The spread will continue to remain inverted until liquidity eases and rate hike worries go out of the market. Corporate bond yields rose by 7bps week on week on the back of liquidity worries. Five and ten year benchmark AAA corporate bonds closed last week at 9.50% levels each while five and ten year credit spreads closed at 99bps and 97bps levels respectively. Money market security yields moved up with one year bank CD (Certificate of Deposit) rates moving up by 15bps on liquidity concerns. Corporate bond yields will continue to be pressured on liquidity issues.
Maturity of Rs 14,000 crores of CMB (Cash Management Bills) in the second fortnight of September will bring part of the advance tax outflows into the system. The rest of the advance tax payments will go towards repaying the government’s overdraft with the RBI, which stood at Rs 28,651 crores as of 9th September. The government will start the second half of fiscal 2011-12 with a cash position of zero to negative
The second half borrowing calendar will be released on the 3rd of October. The government in the first half of fiscal 2011-12 had completed Rs 250,000 crores of the budgeted borrowing of Rs 417,000 crores for full year 2011-12. The market will wait and watch for increase in the borrowing numbers due to the higher subsidy outgo faced by the government due to a 15% rise in oil prices this year. Fuel subsidy outgo can move up at least three times from the budgeted levels of Rs 23,600 crores. The government is claiming that it can stick to its budgeted borrowing program but given its perennial deficit this fiscal and higher subsidy outgo the math do not work out.
The bond market will start factoring in policy rates remaining at current levels of 8.25% on the repo for the next few months. The RBI is widely expected to maintain rates status quo going forward on expectations of past rate hikes working its way to lowering inflation expectations. RBI has recognized downside risk to its GDP forecast of 8% for 2011-12 on the back of downward revisions to global GDP growth by the IMF due to the ongoing debt crisis. Falling inflation expectations coupled with downside risk to growth forecasts will keep policy rates from being hiked.
Government bond auction
There are no government bond auctions scheduled for the second half of September 2011. The RBI will auction State Development Loans (SDL) for Rs 4100 crores this week.