The government bond market is expecting the RBI to cut the Repo rate by a minimum of 25bps in its mid quarter policy review on the 19th of March. The market will also expect the Central Bank to cut the Repo rate in its April 2013 annual policy for fiscal 2013-14. However the market is apprehensive on what government bonds to buy in anticipation of rate cuts as all the current On-The-Run bonds will go Off-The-Run in April. The reaction of the market to the positive inflation data reflects the markets apprehension on the bonds to buy on rate cut expectations.
Inflation as measured by the WPI (Wholesale Price Index) came in at 6.84% for the month of February 2013. The headline inflation printed higher than market expectations of 6.60% but the fall in manufacturing inflation is seen as highly positive for rate cuts. Manufacturing inflation fell to levels of 4.51% in February from levels of 4.81% seen in January 2013. Manufacturing inflation is down from peaks of 6.25% seen in September 2012 reflecting the fall in aggregate demand in the economy.
GDP growth at decade lows of 4.5% in the third quarter of 2012-13 suggests that demand is falling sharply in the economy. The fall in demand is corroborated by the negative growth in passenger car sales for the fiscal 2012-13 and tax collections for the year falling behind targets.
The benchmark government bond the 8.15% 2022 bond saw yields rise 2bps week on week despite rate cut expectations. The other well traded bonds of 8.33% 2026 and 8.97% 2030 also saw yields close up 3bps each. On the other hand OIS (Overnight Index Swaps) yields and corporate bond yields trended down on the back of rate cut expectations. One and five year OIS yields fell 7bps each while five and ten year corporate bond yields fell 10bps each week on week. Government bonds will lag OIS and corporate bonds in terms of fall in yields as the market goes into a fresh government borrowing program starting April 2013.
The outstanding amounts on the 8.15% 2022 bond, the 8.33% 2026 bond and the 8.97% 2030 bond are Rs 70,000 crores, Rs 60,000 crores and Rs 73,000 crores respectively. The bonds are just one to three auctions away from reaching outstanding limits of around Rs 80,000 crores. In effect these benchmark bonds will stop becoming benchmark bonds in April as fresh bonds are issued for benchmarking purposes. The market would prefer to sell the current benchmarks and bid for the new bonds to be issued in April auctions. Hence benchmark government bonds will underperform the broad market in the next couple of weeks.
Liquidity as measured by bids for repo in the LAF (Liquidity Adjustment Facility) auction of the RBI tightened by Rs 49,000 crores week on week with bids for repo averaging Rs 107,000 crores on a daily basis last week against an average of Rs 58,000 crores seen in the week before last. Liquidity tightened on the back of 15th March advance tax outflows. Liquidity is expected to ease towards the month end when the government disburses funds for its subsidy and other commitments