The government’s delay in confirming the extension of term for the RBI Governor Dr. Raghuram Rajan can lead to heavy costs if not set right soon. Like the Indian hockey team that fought so hard in the Champions Trophy to come to the finals and missed penalties to lose to Australia, the Indian government too had built up credibility with markets and may have missed the penalty to carry the credibility forward.
Dr Rajan has sent a note to RBI staff on his intention to not take up a second term as RBI governor. In the note he highlighted RBI’s achievements since his tenure including lowering inflation expectations, steadying the INR, building fx reserves to record highs and cleaning up bank’s balance sheets. He also highlighted the fact the FCNR B outflows in September to November 2016 period would not have material impact on fx reserves and on liquidity and INR.
Dr.Rajan’s note to RBI staff before the crucial Brexit vote on 23rd of June will initially spark a mild sell off in bond markets and INR. However given that the RBI will be run by a Monetary Policy Committee with the Governor largely providing direction to the policies, the market will look at other global and domestic factors for direction post Brexit. RBI by law will target inflation and policies will be in accordance with the inflation target. However the government must appoint a new governor soon and the governor must not be seen as pliable to the government.
Dr.Urjit Patel, deputy governor, will be a good choice as many of the current RBI policies have been formed by committees headed by him.
The benchmark ten year bond, the 7.59% 2026 bond saw yields closing up by 1bps at 7.50% levels last week. The 8.27% 2020 bond saw yields closing up by 1bps at 7.32% levels. The 7.88% 2030 bond and 8.13% 2045 bond saw yields closing up by 1bps each at 7.78% and 7.85% respectively. Government bond yields are likely to rise on the back of Dr. Rajan’s note to RBI staff and on the back of worries of Brexit.
OIS market saw one year OIS yields close up by 1bps and five year OIS yields close up by 2bps week on week. One year OIS yield closed at 6.69% while five year OIS yield closed at 6.78%. OIS yield curve will rise on Dr. Rajan and Brexit.
Benchmark AAA corporate bond yields closed up last week. Three year bond yields closed up by 2bps at 7.93% levels with spreads up by 4bps at 61bps levels. Five year bond yields closed up by 5bps at 8.06% with spreads up by 4bps at 56bps levels while ten year bond yields closed up by 3bps at 8.28% with spreads up by 2bps at 64bps levels. Corporate bond yields will rise marginally following government bond yields and OIS yields.
System liquidity as measured by bids for Repo, Reverse Repo, Term Repo and Term Reverse Repo in the LAF (Liquidity Adjustment Facility) auctions of the RBI and drawdown from Standing Facilities (MSF or Marginal Standing Facility and Export Credit Refinance) was in deficit of Rs 694 billion as of 17th June. The deficit was Rs 130 billion in the week previous to last. Government surplus was zero last week, down by Rs 160 billion week on week. Advance tax outflows of around Rs 800 billion last week led to liquidity being in deficit. RBI is conducting OMO of Rs 100 billion this week to add liquidity into the system.