Bond markets have had a volatile start to the fiscal year 2012-13, with ten year benchmark bond yields swinging 25bps up and down on the back of government bond auction issues. The benchmark ten year bond the 8.79% 2021 bond, saw yields touch highs of 8.75% in the first week of April before coming back down to close last week at levels of 8.47%. Bond yields will see volatility on the back of RBI annual policy statement scheduled for the 17th of April before settling down to a range. The heavy government bond supply for the first half of this fiscal will keep yields from reacting sharply downwards while positive sentiments on rate cuts will keep yields from rising too high.
The market is going into the RBI policy with expectations of a repo rate cut. RBI is expected to cut the repo rate by a minimum of 25bps in its annual policy for fiscal 2012-13. A 25bps cut in repo with expectations of more cuts ahead will keep bond yields at levels of 8.45% to 8.60%. There is a possibility of the RBI cutting rates by 50bps given weak IIP (Index of Industrial Production) growth numbers. The IIP growth number for January 2012 was revised to 1.8% from 6.8% levels while the February IIP growth came in at 4.1% against expectations of 6.4%. RBI is likely to give more weight to growth in this fiscal’s monetary policy given that inflation is trending below 7% levels and sentiments on global economic growth are extremely weak. A 50bps cut in repo will bring down ten year bond yields to 8.20% levels and the trading range will be 8.15% to 8.30% post policy.
Inflation for March 2012 is expected to come in at 6.7%, which is close to the RBI own forecasts of around 7%. The drivers of inflation are not very apparent, except for global oil prices, which are ruling at one year highs. The fact that China’s first quarter GDP growth at 8.1% was the slowest in three years and was below the 8.9% growth seen in the last quarter of 2011 will weigh on commodity prices. The Reuters CRB commodity index, which track a basket of 19 commodities, is down 13% over the last one year, indicating the effect of global economic weakness on commodity prices.
The Rupee, which is down 15% against the US Dollar over the last one year, will weigh on RBI’s mind when it sets the policy for 2012-12. A weak INR exacerbates the country’s oil import bill, which in turn leads to a wider trade deficit and a wider current account deficit. Current account deficit for 2011-12 is placed at 3.6% of GDP, a full percentage point higher than the 2010-11 deficit of 2.6% of GDP. RBI is forced to intervene in the market to sell US Dollars to prevent extreme volatility in the Rupee, and the USD selling leads to liquidity shortage in the system.
RBI has cut CRR by 125bps over the last three months to release Rs 80,000 crores of liquidity into the system. However the liquidity released by the CRR is not helping banks as it only negates the liquidity sucked out through USD sales. Hence RBI will have to ease policy significantly if it wants the accommodative policy stance to work into the economy.
Liquidity as measured by bids for repo in the LAF (Liquidity Adjustment Facility) auction of the RBI, eased last week on the back of government spending and banks releasing excess funds into the system. Banks hoard liquidity in March and all this comes back into the system in April. Easing liquidity has driven down short end CD (Certificate of Deposit) rates with June 2012 maturity CD’s trading 200bps down from levels seen in end March. CD yields will stay down if RBI cuts policy rates.
OIS (Overnight Index Swaps) yields dropped across the curve with one and five year OIS yields dropping by 9bps week on week. The curve will shift down if RBI cuts rates with one year OIS yields falling faster than five year OIS yields, as lower repo rates and easing liquidity is highly positive for one year OIS yields.
Government bond auctions and OMOs
The government auctioned Rs 15,000 crores of bond this week. The bonds auctioned were the 8.24% 2018 bond for Rs 4000 crores, the 8.79% 2021 bond for Rs 7000 crores, the 8.28% 2027 bond for Rs 2000 crores and the 8.33% 2036 bond for Rs 2000 crores. The cut offs came in at 8.56%, 8.47%, 8.74% and 8.80% respectively.
The government is auctioning Rs 16,000 crores of bonds this week.