Bond market reaction has been muted to the policy with the benchmark ten year bond, the 8.40% 2024 bond seeing yields fall marginally by 2bps post policy. The bond is trading at levels of 8.47% and given prospects of policy stability, the yield will trend down on inflation expectations that are expected to come off going forward.
The RBI Governor, in his Bi-Monthly Policy Statement on the 30th of September, focused more on practical issues facing the banking system rather than on broad policy. He continued to keep his focus on Real Positive Interest Rates with glide path of CPI (Consumer Price Inflation) at 8% for January 2015 and 6% for January 2016. He believes that the inflation targets are well achievable though risks in the form of food inflation and asset prices bubbles due to global central bank liquidity are threats to domestic macro economic stability and inflation.
The bond market was worried on the RBI lowering SLR (Statutory Liquidity Ratio) from levels of 22% as the LCR (Liquidity Coverage Ratio) comes into force starting January 2015. LCR is defined as Stock of High Quality Liquid Assets (HQLAs) / Total Net Cash Outflows over the Next 30 Calendar Days. Banks have to move into LCR regime as follows: 60% in January 2015, 70% in January 2016, 80% in January 2017, 90% in January 2018 and 100% in January 2019. The percentages mean that banks have to have HQLAs worth 30 calendar days of net cash outflows from run on deposits to redemption of liabilities to restricted access to market borrowings.
Government securities that were over and above SLR were defined as HQLA and MSF limit as defined by the RBI (currently at 2% of NDTL) were allowed to be marked as HQLA. The bond market was worried that the RBI would cut SLR in order for banks to move to the LCR regime as various workings suggested that SLR would have to below 20% for banks to fully abide by LCR norms. A cut in SLR would mean lower demand for government securities by banks leading to rise in bond yields.
RBI has clarified that banks can mark 5% of their NDTL under SLR as HQLA and this would take away the need to cut SLR in the immediate future. The market would expect the RBI to maintain SLR at current levels of 22% and bring it down when government lowers its fiscal deficit from current budgeted levels of 4.1% of GDP.
RBI has put out a calendar for HTM (Held to Maturity) portfolio limits that will come down to 22% from current levels of 24% of NDTL by September 2015. Starting January 2015, HTM will be cut by 0.5% of NDTL every quarter.
RBI lowered the access to Export Credit Refinance from 32% of eligible export credit to 15% of eligible export credit and is likely to stop it altogether going forward as recommended by the Urjit Patel committee to move away from sector specific refinance. Liquidity has eased in the system and banks have lowered their drawdown from Export Credit Refinance to 10% of eligible exports from available limits of 32% of eligible exports. Read our Liquidity Cheat Sheet for liquidity analysis.