The government surplus as per our liquidity estimates stands at Rs 1300 billion after the RBI dividend payout of Rs 520 billion.
The high surplus cash balance that the government is running has led to liquidity becoming tighter in the system. Liquidity as measured by banks bids for LAF (Liquidity Adjustment Facility) repo, reverse repo and term auctions, banks drawdown from MSF (Marginal Standing Facility) and Export Credit Refinance was at Rs 1200 billion last week, up by Rs 350 billion from Rs 850 billion seen in the week previous to last.
RBI is having to provide liquidity through term repo auctions. The central bank has lent Rs 750 billion through term repos to the system. While the government and RBI are still mulling over auctioning of government cash balances, the high surplus is hitting liquidity.
The government has cut its dated government borrowing by Rs 160 billion given its healthy cash balances. The first half borrowing of Rs 3680 billion has been lowered to Rs 3520 billion. Advance tax inflows expected at around Rs 800 billion would further increase the government cash balance leading to more pressure on RBI to manage liquidity.
The cut in government borrowing is good for bond yields that have come off by 15bps from highs seen last week. The benchmark ten year bond, the 8.40% 2024 bond saw yields fall 12bps week on week to close ta 8.52% levels. The bond yield is likely to trend down further on the cut in government borrowing but the fall will be capped on short term liquidity worries.
Five year OIS yield fell last week on the back of fall in government bond yields. Five year OIS yield fell 6bps to close at 8.11%. One year OIS yield fell 1bps to closet at 8.50% levels. One year OIS yield will stay pressured on expected liquidity tightness post advance tax outflows in September.
Ten year AAA credit spreads rose by 13bps week on week to close at levels of 62bps on the back of fall in yields on the ten year government bond. Five year AAA spreads rose 6bps on the back of fall in yield by 15bps on the 7.28% 2019 government bond. Five year AAA spreads closed at 57bps levels last week. Credit spreads will rise as government bond yields fall on cut in government borrowing but corporate bond yields stay sticky on the back of expected tightness in liquidity.