The bond market was eagerly awaiting a diesel price hike that would have killed two birds with one stone. A diesel price hike would have put paid to fears of higher than budgeted government borrowing for the second half of 2012-13 and would have also let RBI ease its tough stance on the government’s lack of credible fiscal consolidation plan. There were strong rumors of a diesel price hike that was supposed to take place last week but the price hike rumors was put paid by the comments of the oil minister that there will be no fuel price hike in the immediate future.
Bond markets showed its disappointment on the lack of diesel price hike by taking up bond yields by 4bps from lows seen during last week. The ten year benchmark bond, the 8.15% 2022 bond closed last week at 8.20% levels up from lows of 8.16% seen during the week. Markets will now go with fingers crossed on policy rate cuts by the RBI in its mid quarter policy review on the 17th of September 2012.
RBI has many reasons to cut rates including the fact that GDP growth is expected to fall sharply from estimated levels of 6.5% largely on the back of lack of credit off take and on the back of below normal monsoons. Incremental Credit Deposit Ratio (ICDR) for the fiscal 2012-13 year to date is just 9.5% indicating the lack of credit growth. Monsoons have been below normal this year despite some recovery in August and September and this will lower agriculture growth leading to pressure on GDP growth. However the government is showing no signs of improving its fiscal condition by reducing the fuel subsidy burden, which is expected to go up by at least three times from the budgeted subsidy of Rs 43,000 crores. The subsidy bill has in fact touched 75% of the budgeted fuel subsidy in the first quarter of 2012-13. RBI will take the lack of a diesel price hike as signs of poor fiscal policy and will reconsider the pace of rate cuts despite threats of growth falling off the cliff.
Bond markets have two positive going for them at present. One is the easing system liquidity and the second is the appetite for government bonds shown by the banks. Liquidity as measured by the bids for repo in the LAF (Liquidity Adjustment Facility) auction of the RBI saw bids for repo averaging Rs 14,300 crores on a daily average basis against bids of Rs 47,800 crores seen in the week previous to last. Liquidity will tighten as advance tax payments go out of the system in mid September but the tightness will be temporary, as the money will flow back into the system in the form of government spending. Liquidity is helped by a weak ICDR as banks are left with surplus liquidity due to weak credit growth. Banks are using the excess liquidity to purchase government bonds (banks have bought government bonds worth over Rs 180,000 crores in fiscal 2012-13 to date) and this appetite is helping ten year government bond yields to stay at around 8.20% levels despite worries of higher supply going forward.
Money market securities yields are dropping in the face of easing liquidity pressures. One year CD (Certificate of Deposit) yields have dropped by 70bps from highs seen in April 2012 and are currently trading at around 9% levels. Banks will lower deposit rates further as weak credit growth force them to focus on margins and lower deposit rates will pull down CD yields.
Corporate bonds will benefit from easing liquidity conditions but this will be restricted to only the top rated borrowers. Benchmark AAA ten year corporate bond yields at 9.25% levels will look to come off on demand for higher yields from investors.
The OIS (Overnight Index Swaps) yield curve lost its inversion by 7bps last week on the back of easing liquidity conditions. One year OIS yield came off by 3bps while the five year OIS yield rose by 4bps week on week and the five over one OIS spread closed at a negative 56bps last week. The OIS yield curve has been inverted for almost a year and half and this inversion will look to come off going forward on easing liquidity conditions.
Government bond auctions
The government auctioned Rs 16,000 crores of bonds last week. The bonds auctioned were the 8.07% 2017 bond for Rs 4000 crores, the 8.15% 2022 bond for Rs 7000 crores, the 8.97% 2030 bond for Rs 3000 crores and the 8.33% 2036 bond for Rs 2000 crores. The cut offs came in at 8.21%, 8.19%, 8.58% and 8.54% respectively. There is no government scheduled for this week.