RBI will not take any major policy steps on the 7th of June and even in August until the government finalizes the RBI governor post given that Dr Rajan’s term ends in August.
RBI in its April 2016 policy, cut the Repo Rate by 25bps and announced that it will bring down system liquidity from deficit to neutral. System liquidity was in deficit of over Rs 1000 billion in April. System liquidity going into the 7th June Bi-Monthly Policy Review is almost neutral.
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 20 billion as of 3rd June. The deficit was Rs 929 billion in the week previous to last. Government surplus was Rs 36 billion last week, down by Rs 350 billion week on week.
RBI has added Rs 750 billion of liquidity through OMO bond purchases in April and May. This liquidity infusion has helped take up liquidity from deficit of over Rs 1000 billion to neutral territory. Going forward, apart from short term stress on liquidity through advance tax outflows, there is no real expected change to structural liquidity.
The FCNR B swap maturities of around USD 30 billion in the months of September to November 2016 could lead to temporary shortfall in liquidity but the RBI is covered for this through equivalent fx forward purchases.
The question now is what will be the next action of the RBI. The expectations for any action on the 9th of June are low and RBI is expected to maintain status quo on rates and liquidity. RBI will watch for Fed actions on interest rates and progress of monsoons in India before taking any policy steps in the coming months.
The Fed was widely expected to raise rates in its meeting this month but the May jobs report that was released on Friday placed a damper to the rate hike prospects. US economy saw just 38,000 jobs being created in May, the slowest pace of addition in almost six years. Even though unemployment rate fell to 4.7% from 5%, the slow pace of hiring has spooked economists who are now taking off June rate hike bets.
Fed maintaining status quo on rates in June would add fresh uncertainty to markets and RBI would be wary of this uncertainty effect on capital flows.
The monsoons are expected to be normal and even above average but until the rains set in, RBI will be watchful given the drought conditions prevailing in the country.
The benchmark ten year bond, the 7.59% 2026 bond saw yields closing up by 2bps at 7.49% levels last week. The 8.27% 2020 bond saw yields closing flat at 7.35% levels. The 7.88% 2030 bond saw yields rising by 1bps to close at 7.77% levels while the 8.13% 2045 bond saw yields closing down by 3bps at 7.84% levels. Government bond yields could rise going into RBI policy this week as the markets factor in RBI stopping OMOs for the present.
OIS market saw one year OIS yields rising by 1bps and five year OIS yields rising by 3bps week on week. One year OIS yield closed at 6.68% while five year OIS yield closed at 6.79%. OIS yield curve will steepen as RBI maintains status quo on rates.
Benchmark AAA corporate bond yields closed mixed last week. Three year bond yields closed flat at 7.98% levels with spreads up by 2bps at 63bps levels. Five year bond yields closed flat at 8.08% with spreads unchanged at 59bps levels while ten year bond yields closed up by 2bps at 8.25% with spreads flat at 62bps levels. Corporate bond yields will tend to fall as liquidity improves.