The government is auctioning Rs 80 billion of bonds this week against original auction schedule of Rs 140 billion. The reduced auction size is due to the high cash surplus that the government is running with the RBI. Government cash surplus has been affecting system liquidity that has seen volatility in the last couple of weeks with liquidity deficit rising and falling by around Rs 500 billion. Call money rates have moved in a wide range of 100bps between 8% and 9% on the back of rise and fall in liquidity deficit.
RBI is expected to pay a dividend of Rs 460 billion to the government this month and the payout will swell government’s cash surplus further. Government is estimated to be running a cash surplus of around Rs 600 billion at present.
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 848 billion last week against Rs 1174 billion seen in the week previous to last. Liquidity has eased in the system on government spending.
The lower auction size will calm the bond market that has been hit by a market negative policy review of the RBI on the 5th of August 2014. RBI signaled that any rate cuts would be deferred until inflation trends down towards 6%. RBI also cut SLR (Statutory Liquidity Ratio) of banks by 50bps, which is seen as negative for bond demand.
Government bond yields rose 12bps to 25bps last week on the back of the market taking out rate cut bets from yields. Benchmark ten year bond, the 8.40% 2024 bond saw yields rise by 12bps while the five year bond the 7.28% 2019 bond saw yields rise by 25bps to close at levels of 8.64% and 8.73% respectively. Government bond yields will come off initially this week on the back of reduced size of bond auctions but will not see sustained fall in yields as the market worries on the timing of rate cuts.
Five year OIS yield took out all rate cut bets and rose 27bps week on week. Five year OIS yield was trading at below repo rate levels of 8% at 7.90% pre policy and rose to 8.17% levels post policy. One year OIS yield rose 14bps to close at 8.51% levels. The five over one OIS spread flattened by 13bps to close at 34bps levels. OIS yields will trend down initially on reduced size of bond auction but will not see sustained falls as rate cut hopes are taken out of yields.
Ten year AAA credit spreads fell by 9bps week on week to close at levels of 49bps on the back of rise in yields on the ten year government bond. Five year AAA spreads fell 16bps on the back of the sharp rise of 25bps in the yield on the 7.28% 2019 government bond. Five year AAA spreads closed at 51bps levels last week. Credit spreads will move in a 10bps to 15bps range largely on movement of yields on government bonds.