28 Nov 2020

RBI 28th January 2014 Policy Review will Focus on Liquidity Management – Positive for Bond/ Bond Fund Investors

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RBI’s third quarter review of the annual 2013-14 monetary policy scheduled for the 28th of January 2014 will not see any changes to key policy rates of CRR and Repo.

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Arjun Parthasarathy

RBI’s third quarter review of the annual 2013-14 monetary policy scheduled for the 28th of January 2014 will not see any changes to key policy rates of CRR and Repo. However, RBI will stress on making liquidity comfortable in the banking system to enable banks to provide credit to the economy.

RBI’s liquidity focus has been made clear in the last few weeks with the central bank conducting term repo auctions for Rs 690 billion and announcing an OMO (Open Market Operation) bond purchase auction for Rs 100 billion. The banking system liquidity has tightened on the back of the government running surplus cash that is parked with the RBI. Banks borrowed Rs 1200 billion from the RBI as of 17th January 2013. The borrowing included Rs 400 billion under repo in the LAF (Liquidity Adjustment Facility), Rs 590 billion under term repos (7 to 28 days) and Rs 21 billion under MSF (Marginal Standing Facility).

The focus on liquidity is expected to continue throughout fiscal year 2014-15. The growth – inflation dynamics may not warrant a rate cut or rate hike but it would warrant easy liquidity in the system. The fiscal year 2014-15 would see the economy growing at a higher pace than the 5% growth levels it has seen over the last two years. Inflation as measured by the CPI (Consumer Price Index) and WPI (Wholesale Price Index) is expected to trend down from levels of 9.87% and 6.16% seen in December 2013.

The current borrowing corridor for banks is the Repo – MSF corridor that is in the 7.75% to 8.75% range. The MSF is the backstop for banks not being able to borrow funds in the market and overnight rates will be capped at 8.75%. A system with deficient liquidity would continue to borrow funds at the repo rate that is restricted to 0.5% of NDTL (Net Demand and Time Liabilities) of banks. The repo rate of 7.75% will act as the floor as long as the system is deficient in liquidity.

RBI’s comfort to the market on liquidity would keep bond yields from rising in the market. The market does not expect any changes to policy rates and the RBI providing enough liquidity to the market will drive markets to hold on to bonds. On the other hand positive signals from the government on the fiscal front and RBI purchasing bonds from the market through OMOs are factors for driving down bond yields.

The government is expected to lower its borrowing for fiscal 2013-14 by Rs 150 billion. The fiscal deficit budgeted at 4.8% of GDP is expected to come off to 4.65% of GDP on the back of a cut of 20% in plan expenditure. Ten year benchmark government bond yields have come off by 40bps since the beginning of calendar year 2014. The 8.83% 2023 bond is trading at yields of 8.52% and the market would look to take down yields further on the back of lower bond supply, status quo on RBI policy rates and comfort on liquidity.

Bond/ bond fund investors are benefitted by stable to positive sentiments in the bond markets. Bond yields are still high in the market given borrowing costs in the range of 7.75% to 8.75% and that lowers risk for investors. One, three, five and ten year AAA corporate bond yields are at levels of 9.35%, 9.40%, 9.45% and 9.45% and are expected to stay stable at these levels. Government bond yields have come off by 40bps in January 2014 and are likely to move in an 8.40% to 8.60% range at the ten year level.

FII’s have turned net buyers of bonds in December 2013 and January 2014 with purchases of over USD 2 billion. FII buying bonds is positive for bond yields as well as the INR. A positive INR will enable RBI to take policy decisions in a normal environment.



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