The bond market is confused on the intentions of the RBI. The central bank’s official stance is that the is the operational rate for the market but its actions suggest that its holding rates in the Repo-MSF corridor. The result of the confusion is a spike in yields on money market securities and a distinct lack of trading interest in
One year Certificate of Deposit (CD) rates have shot up to levels of 9.75% while 91 day and 364 day treasury bills yields are at over 9%. Money market securities yields are at five months highs. March 2014 is going to be a month of tight liquidity given advance tax and spectrum auction outflows (expected at around Rs 750 billion to Rs 800 billion) and RBI has announced that it will hold term repo auctions to ensure sufficient liquidity in the system.
The repo rate is at 8% and MSF (Marginal Standing Facility) rate is at 9%. In the peak of INR volatility in July 2013, the MSF rate was 300bps above the repo rate, and as volatility subsided, the MSF rate was brought back to levels of 100bps over repo rate.
RBI has restricted bank borrowing from the repo window in the LAF (Liquidity Adjustment Facility) to 0.5% of NDTL (Net Demand and Time Liabilities). Hence the availability of funds at the repo rate of 8% is just around Rs 400 billion. The market at present is borrowing Rs 1310 billion from the RBI, through repo and term repo auctions.
Term repo rates in the 14 day and 28 day auctions have been in the range of 8.20% to 8.60%. Tight liquidity conditions will ensure that MSF becomes the operational rate as markets access the backstop window for funds. Overnight rates will go to 9% and higher in March if term repo auctions fall short of system liquidity requirement.
Why is the RBI reluctant to remove the cap on banks access to LAF if the repo rate is the stated operational rate? Banks should have unlimited access to funds at the repo rate and if RBI believes that banks are relying too much on repo, it can start rejecting bids in the LAF auctions and then carry out term repo auctions. At a time when economic outlook is weak, elections are coming up and banks are starved for funds, the central bank can at least ensure liquidity to the system at a stated operational rate.
The government bond yield curve shifted marginally down last week as the government, in its for fiscal 2014-15, showed lower borrowing for fiscal 2014-15. The five year benchmark bond, the 7.28% 2019 bond saw yields fall by 4bps while the ten and thirteen year benchmark bonds, the 8.83% 2023 and 8.28% 2027 bonds saw yields fall by 2bps and 3bps respectively. Volumes in the market came off by 15% week on week. Government bonds will move in a tight range on liquidity worries.
Five and ten year benchmark AAA corporate bond yields rose by 9bps and 7bps each week on week while five and ten year credit spreads rose by 19bps and 9bps to close at levels of 67bps to 72bps respectively. Corporate bond yields are likely to stay at higher levels given expected tightness in liquidity.
OIS (Overnight Index Swaps) market saw the curve shift down on the back of lower government bond yields. One and five year OIS yields fell by 8 bps and 2 bps respectively to close at levels of 8.65% and 8.48% and the five over one OIS spread flattened by 6bps to close at 17 bps levels. OIS yields are likely to stay ranged at current levels given tight liquidity conditions.