CRR hike, auction rejections send widely confusing signals
RBI hiked the CRR by 1% in its policy review last week, as it sought to slowly normalize policy in the face of higher inflation. Growth prospects are brighter given high government spending and this is signal for inflation to rise. Government forecast a fiscal deficit of 6.8% of GDP for FY22 while it was at a whopping 9.5% of GDP for FY 21.
In the same breath, the RBI rejected all bids in the 5 and 10 year auction last week, as the market bid at higher yields on rising inflation expectations. The bond market is now totally confused on what to do, as it is not allowed to air its views on bond yields and with prospects of endless high borrowing, the market will just stop trading and RBI will force banks and government insurers to absorb the higher borrowing at artificially held yields.
Banks have significantly lost market share in government bonds
In the last 10 years, banks holding of government bonds as % of total outstanding has come down by 9%. The cause if the lower SLR rate that has dropped from 25% to 18.5% and low double digit to single digit deposit growth. Insurance companies and RBI have increase their holding of government bonds to make up for banks slower offtake.
This is a significant trend as the RBI has to widen the market for bonds to absorb the high borrowing requirement by the government.
Fiscal year | Bank holding in gilt securities (%) | Aggregate Bank Deposit (Rs trillion) | Incremental credit to deposit (%) |
FY21(Sep-20) | 38.55 | 146.25 | 25.49% |
FY20 | 40.41 | 135.71 | 60.54% |
FY19 | 40.28 | 125.73 | 99.60% |
FY18 | 42.68 | 114.75 | 112.81% |
FY17 | 40.46 | 108.05 | 32.45% |
FY16 | 41.81 | 97.21 | 85.04% |
FY15 | 43.30 | 85.86 | 65.18% |
FY14 | 44.46 | 77.39 | 75.94% |
FY13 | 43.86 | 67.51 | 76.81% |
FY12 | 46.11 | 59.04 | 96.24% |
FY11 | 47.03 | 51.40 | 94.40% |
Government bonds, SDL and OIS yield movements.
Last week witnessed significant rise in government bond yields due to more than expected rise in fiscal deficit for FY21 and FY22. During the week, 5.85% 2030 yield rose by 16 bps to 6.07%. 5.77% 2030 yield rose by 19 bps to 6.13%. 5-year benchmark bond, 5.22% 2025 yield increased by 23 bps to 5.45%. Long term paper 7.16% 2050 yield moved up by 16 bps to 6.70%.
The spread of 10-year bond over 5-year bond (5.22% 2025) came down by 7 bps to 62 bps from 69 bps in previous week. In the same line, 15-year benchmark over 10-year benchmark spread declined to 42 bps from 44 bps while 30-year benchmark over 10-year benchmark spread stood steady at 62 bps.
In the SDL auction conducted last week, average 10-year SDL yield soared to 6.89% from 6.62% from previous week. The spread with G-sec benchmark rose to 76 bps from 70 bps.
On weekly basis, 1-year OIS yield rose by 5 bps to 3.8% while 5-year OIS yield jumped by 32 bps to 4.99%.
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