RBI has announced an OMO bond purchase auction for Rs 150 billion scheduled for the 31st of May 2016. RBI, if it accepts bids for the full auction amount, will have conducted three auctions in May and would have bought Rs 450 billion of bonds through OMO. RBI in April, conducted two OMO auctions and bough Rs 300 billion of bonds.
RBI is keen on bringing down system liquidity from deficit to 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 929 billion as of 27th May. The deficit was Rs 1190 billion in the week previous to last. Government surplus was Rs 426 billion last week, up by Rs 130 billion week on week.
Government surplus will rise in June on advance tax payments and that will further strain system liquidity. RBI will also be conscious of the liquidity impact of its fx forward sales, which it has built up for meeting the FCNR B deposit maturities that are coming up in September to November period. RBI has forward purchases too to neutralize the sales but with maturity mismatches, liquidity could turn deeply negative before turning positive.
RBI OMO purchases while adding liquidity is also leading to lowering the net supply of bonds to the market. The government has auctioned Rs 1200 billion of bonds since April and with RBI buying Rs 750 billion of bonds and with redemptions of over Rs 400 billion, net government bond supply is negative.
Government bond markets have seen bond yields stagnate with the benchmark ten year bond, the 7.59% 2026 bond seeing yields move in tight 6bps range over the last two months. Banks are not buying government bonds and have actually been net sellers since the beginning of this calendar year. Banks lack of demand for bonds is worrying markets and while RBI is filling the gap, the genuine lack of demand can cause problems for government borrowing going forward.
The benchmark ten year bond, the 7.59% 2026 bond saw yields closing down by 1bps at 7.47% levels last week. The 8.27% 2020 bond saw yields closing down by 2bps at 7.35% levels. The 7.88% 2030 bond saw yields falling by 1bps to close at 7.76% levels while the 8.13% 2045 bond saw yields closing up by 1bps at 7.87% levels. Government bond yields are likely to trend down on OMOs but fall will be limited given no rate cut expectations in RBI policy in June.
OIS market saw one year OIS yields falling by 1bps and five year OIS yields rising by 1bps week on week. One year OIS yield closed at 6.67% while five year OIS yield closed at 6.75%. OIS yields will stay ranged until liquidity conditions ease.
Benchmark AAA corporate bond yields closed mixed last week. Three year bond yields closed up by 4bps at 7.98% levels with spreads up by 4bps at 61bps levels. Five year bond yields closed flat at 8.08% with spreads up by 2bps at 59bps levels while ten year bond yields closed flat at 8.23% with spreads up 1bps at 62bps levels. Corporate bond yields will tend to fall as liquidity improves.