The 25bps CRR (Cash Reserve Ratio) cut by the RBI in its policy review on the 29th of January has failed to improve market sentiments on liquidity. The CRR cut released Rs 18,000 crores of liquidity into the system but money markets are jittery on liquidity conditions going into the end of fiscal 2012-13.
The nervousness of markets on liquidity was felt most acutely in yields of bank CDs (Certificate of Deposits). One year maturity CD yields rose by 40bps week on week to close at levels of 9.10%. The sharp rise in CD yields despite a 25bps repo rate and 25bps CRR cut by the RBI is a reflection of expected liquidity situation in March 2013.
The daily market borrowing under the LAF (Liquidity Adjustment Facility) window of the RBI averaged Rs 104,000 crores on a daily basis last week against an average of Rs 97,000 crores seen in the week before last. The month of February will see the government borrowing Rs 48,000 crores from the market to complete its scheduled borrowing program for the fiscal year. State governments are expected to borrow around Rs 20,000 crores in February. Central government and state government borrowing is likely to place further pressure on liquidity as government spending slows down.
The central government is keeping excess funds with the RBI leading to liquidity being sucked out of the system. Deposits of the central government stood at Rs 40,000 crores as of 25th January 2013. State governments too are placing excess funds in 14 day treasury bills with amount outstanding of Rs 105,000 crores. Lack of spending by central and state governments coupled with market borrowings will lead to further drain on system liquidity.
The markets are also worried about the USD 13.5 billion of outstanding forward USD/INR contracts of the RBI (as of November 2012). The maturity of these forward contracts is a liquidity drain from the system and if part of these contracts mature in the next two months, liquidity will be further pressured.
The slow growth in deposits and rising credit growth is hitting liquidity hard. The October 2012 –January 2013 period has seen credit and deposits grow by Rs 233,000 crores and Rs 127,000 crores respectively leading to banks drawing down on liquidity to fund credit growth. The continuation of this trend in the next two months will lead to sharp shortfall in liquidity in the system.
Advance tax outflows will also hit the system in mid March and that will also be a big drain on system liquidity. Banks that are in need of liquidity will have to pay higher rates for funds. CD yields are likely to trend higher in the coming days as banks rush to mop up whatever liquidity that is available in the system.
Banks will raise deposit rates in the short maturity bucket to draw bulk deposits. However as corporates get lured into higher deposit rates, they will withdraw money from mutual funds that in turn will be forced to sell money market instruments to fund the redemptions. This cycle will push up yields of money market instruments such as CD’s and CP’s (Commercial Papers). The sharp rise in CD yields last week is an indicator of further yield spikes ahead.
Government bond yields rose week on week as markets braced itself for government bond supply amidst tight liquidity conditions. The ten year benchmark bond the 8.15% 2022 bond saw yields rise by 2bps week on week to close at 7.90% levels. Bond market will expect RBI to conduct OMOs (Open Market Operations) to infuse liquidity into the system and that will keep bond yields soft going forward.
Corporate bond yields rose week on week on the back of liquidity worries. Five and ten year corporate bond yields rose by 5bps and 7bps respectively. Corporate bond yields are likely to be pressured on the back of tightening liquidity.
OIS (Overnight Index Swaps) markets saw one and five year OIS yields rising by 8bps and 13bps respectively week on week. OIS markets saw paying on the back of liquidity worries and on a non-committal RBI on more rate cuts. Five year OIS yields are also being affected by rising US treasury yields with the ten year US treasury rising by 30bps over the last few months. Five year OIS yields are likely to rise further as markets factor in the negatives of liquidity, no rate cuts and higher US treasury yields.
Government bond auctions
The government auctioned Rs 12,000 crores of bonds last week. The bonds auctioned were the 8.12% 2020 bond for Rs 3000 crores, the 8.20% 2025 bond for Rs 6000 crores and the 8.30% 2042 bond for Rs 3000 crores. The cut off came in at 7.92%, 8.02% and 8.13% respectively. The government is scheduled to auction Rs 12,000 crores of bonds this week and state governments are auctioning Rs 7670 crores of state development loans (SDL).