RBI’s moves to ease bond market pain will see sharp fall in bond yields as the market scrambles to cover its short positions. Ten year government bond yields can fall by 50bps to levels of 8.40% in the next couple of days. Markets will however be wary of the levels at which RBI accepts bids in the OMO auction. Markets will also worry about cut offs in the government bond auctions. Hence bond yields will stay volatile and will take time to stabilize.
Banking sector stocks will benefit from RBI moves to curtail losses on bond portfolios and the bank Nifty that had fallen by 22% since the 15th of July is likely to see a sharp jump in the next few days.
The RBI, unnerved by the volatility of its actions on the INR that touched all time lows against the USD as well as on bond yields that rose to five year highs, has started to relax its tight liquidity stance. The bond market had a violent trading day on the 20th of August 2013 with the benchmark ten year bond yield touching highs of 9.40% in early morning trades before falling all the way back to 8.90%, a fall of 50bps from highs. Bond markets seem to have got a whiff of some easing measures in the offing but those who did not know about the easing measures would have got burnt badly.
The RBI’s announcement of easing liquidity measures came after market hours. The Central Bank has announced an OMO (Open Market Operation) purchase auction of Rs 8000 crores of long dated government bonds on the 23rd of August 2013. The central bank will also scale down the issuance of Cash Management Bills (CMB) to alleviate the tight liquidity conditions that have led to money market security yields crossing 12% levels.
RBI has also addressed the problems of banks losing money on their government bond holdings due to the sharp rise in bond yields. Ten year benchmark government bond yield has gone up from levels of 7.10% to 8.90% levels over the last three months. Banks have to hold government bonds as part of the reserve requirement.
The SLR (Statutory Liquidity Ratio) of banks is 23% of NDTL (Net Demand and Time Liabilities) and banks have to compulsorily hold government bonds for this purpose. Bonds held for SLR need not be marked to market (MTM) and is placed in a category called HTM (Held to Maturity). The HTM portfolio of banks stood at 24.5% of NDTL and banks were required to lower their HTM portfolio to 23% of NDTL, which is also the SLR rate. RBI has now told banks that they need not bring down the HTM portfolio to 23% and they can continue to hold bonds in the HTM portfolio to avoid mark to market losses on their bond holdings.
RBI has also allowed banks to transfer securities that were held for sale (AFS or Available for Sale Portfolio) to the HTM portfolio at yields that were prevailing on the 15th of July. The yield on the ten year benchmark bond, the 7.16% 2023 bond was 135 bps lower on the 15th of July at levels of 7.55% against levels of 8.90% as 20th August. Banks have been allowed to stagger the losses on the bond portfolio over the next three quarters.