SDLs can see higher market liquidity, as RBI purchases SDLs

       •    RBI conducts first ever OMO purchase of SDLs

·         RBI provides option of repaying the funds availed under Targeted Long-Term Repo Operations before maturity

·         5.79% 2030 bond yield closed at 5.87%, down by 6 bps while 5.77% 2030 bond yield closed at 5.84%, down by 9 bps

        •   5-year OIS yield came down by 5 bps to 4.35%

        •   Liquidity stood at Rs 2.65 trillion as compared to Rs 2.89 trillion previous week

SDLs normally trade at spreads over the government bond, implying a certain amount of credit risk, as states cannot print money to service their debt, unlike the central government that can print money. However, SDLs have had an implicit support from both the central government and RBI through loans and overdraft facilities. RBI, until last week, has never explicitly supported SDLs but with its commencing of SDL purchases, the message to markets is very clear that SDLs are credit risk free.

RBI, at this point of time, does not expose its balance sheet to credit risk and with SDL purchases, the credit risk of SDLs is seen at zero i.e there is no risk of default.

SDLs henceforth will be seen as carrying only interest rate risk and liquidity risk and spreads will largely factor in only liquidity risk. Segments of the market that did not invest in SDLs will now start to invest and there would be higher trading and liquidity in SDLs going forward.

RBI first ever SDL OMO purchase auction of Rs 100 billion saw total amount offered by participants at Rs 154.75 billion, out which Rs 100 billion was accepted. Highest cut off yield stood at 6.68% for 7.95% JAMMU KASHMIR SDL 2030.

Consequent to SDL OMO purchase auction announcement, cut off yield on SDL auction   softened. In the weekly SDL auction, the average 10 years SDL cut-off yield came down to 6.55% from 6.63% last week. Spread over benchmark 10-year yield came down to 63 bps from 85 bps seen in the previous week’s auction. SDL auction yield has declined significantly since Apr 20. On 6^th Apr 20, average 10-year SDL yield came in at 7.85% while it stood at 6.55% on 20^th October while spread over benchmark G-sec declined to 63 bps from 143 bps during same period.     

Yield Curve Steepens Sharply

During the week, the 5.77% 2030 yield decreased by 9 bps to 5.84%, the 5.79% 2030 bond yield rose by 6 bps to 5.87%, while 6.45% 2029 bond yield declined by 7 bps to 5.95%. 5-year benchmark 5.22% 2025 yield increased by 13 bps to 5.14%. 6.19% 2034 yield level declined by 7 bps to 6.21%. Long term paper 7.16% 2050 yield declined by 4 bps to 6.73%.

The spread of 10-year bond over 5-year bond (5.22% 2025) rose to 74 bps from 66 bps. The 15-year benchmark over 10-year benchmark spread increased to 36 bps from 33 bps. 30-year benchmark over 10-year benchmark spread increased to 83 bps from 65 bps.

One-year OIS yield came down by 13 bps to 3.59% while the five-year OIS yield declined by 5 bps to 4.35% on a weekly basis.

System liquidity as measured by bids for Repo, Long Term Repo, Reverse Repo, Term Repo and Term Reverse Repo in the LAF (Liquidity Adjustment Facility) auctions of the RBI, drawdown from Standing Facility (MSF or Marginal Standing Facility)  and CMB was in surplus of Rs 2657 billion as of 23rd Oct 2020. Liquidity was in a surplus of Rs 2889 billion as of 16th Oct 2020.