RBI cut the MSF rate by 50bps, held an Rs 10,000 crores OMO (Open Market Operation) purchase auction and infused Rs 19,000 crores through 7 day term repo auctions at 8.80% to ease system liquidity and bring down rates at the short end of the yield curve. The central bank is likely to pursue further liquidity easing measures and will bring down MSF rate to normal levels of 100bps over repo, remove restrictions on LAF (Liquidity Adjustment Facility) access for banks (restricted to 0.5% of NDTL at present), hold more term repo auctions and conduct more OMO purchase auctions if necessary to ease system liquidity.
The intention of the RBI at present is to normalize monetary policy to make the repo rate the operational rate in the system. However at the same time, the central bank believes that it should signal its credibility on controlling long term inflation expectations and that would mean a hike in repo rate from levels of 7.50% to 7.75% or 8%. The bond market is largely expecting a 25bps repo rate hike in RBI policy review on the 29th of October 2013. The central bank hiked the repo rate by 25bps in its 20th September 2013 policy review and had indicated its discomfort with rising inflation expectations.
The domestic economy is faltering with IIP (Index of Industrial Production) growth coming in at 0.6% for the month of August 2013 and just 0.1% for the April-August 2013 period. The IMF (International Monetary Fund) has a pessimistic forecast on India’s GDP growth for fiscal 2013-14 at 3.8% against official estimates of over 5%. RBI, while looking to control long term inflation expectations, will have to make sure that the system has adequate liquidity made available at reasonable rates to cater to any incipient demand in the economy. Hence the central bank is likely to focus on easing system liquidity in its 29th October policy review and may put off repo rate hike until later when liquidity normalizes in the system.
The market is borrowing over Rs 100,000 crores from the RBI on a daily basis with LAF and MSF outstanding at Rs 40,000 crores and Rs 66,000 crores respectively. The 7 day term repo auctions saw the market taking the full amount of Rs 19,000 crores at 8.80%. The banking system is running at an Incremental Credit Deposit Ratio (ICDR) of 83% and with credit demand in the festive season likely to increase, liquidity will be strained in the system.
Government bond yields fell week on week on the back of RBI liquidity easing measures. The ten year benchmark bond, the 7.16% 2023 bond saw yields fall 13bps week on week. The 7.28% 2019 bond saw yields fall by 13bps while yields on the 9.20% 2030 bond fell by 20bps week on week as market bought into higher yields at the longer end of the curve. Government bond yields are likely to trend down further as fears of repo rate hike come off in the market.
The corporate bond yield curve fell sharply last week with one, two, five and ten year corporate bond yields falling by 45ps, 25bps, 30bps and 30bps respectively week on week. Five and ten year benchmark AAA credit spreads fell by 6bps and 16bps to close last week at 78bps and 68bps levels respectively. Corporate bond yields are likely to trend down on expectations of liquidity easing measures by the RBI.
OIS market saw one year OIS yield come off by 25bps and 5 year OIS yield fall by 14bps week on week on the back of RBI lowering the MSF rate. The five over one OIS spread flattened by 11bps to close at a negative 33bps levels. OIS yield curve is likely to move in a narrow range as it has discounted further liquidity easing measures by the RBI.