Mumbai: Yields on short-term money market instruments such as certificate of deposit (CD) and commercial paper (CP) have risen on expectations that liquidity in the banking system will continue to remain tight and another interest rate cut by the Reserve Bank of India (RBI) may not come too soon. RBI cut its policy rate by a quarter percentage point on 29 January to 7.75%.
Yield on three-month CDs rose to 8.93% on Wednesday, the highest level since July 2012, and off the recent lows of 8.26% in October.
Six-month CDs are yielding 9.02%, the highest since August and off September lows of 8.50%.
Yields on the short-term borrowings of companies through CP have also increased, though not as sharply as those for banks.
Three-month CP’s 9.07% yield is the highest since 26 December while six-month CP at 9.35% is the highest since 12 December.
Hitendra Dave, head, global markets, Hongkong and Shanghai Banking Corp. Ltd India (HSBC), said banks are borrowing short-term money from the market on expectations that liquidity will continue to remain tight.
“The fact that government has committed to rein in the fiscal deficit to 5.3% of GDP (gross domestic product) means that they will limit spending, which will keep liquidity tight. Also, lots of banks and companies stayed out of the market expecting RBI to sound really dovish in its monetary policy. They are now coming back as the next rate cut is uncertain,” Dave said.
In its monetary policy review in January, RBI cut the repo rate, its key lending rate, for the first time in nine months. It also slashed banks’ cash reserve ratio (CRR) or the portion of deposits that commercial banks need to keep with RBI by an identical margin.
However, the central bank cautioned on risks that the country faces including the high current account deficit, elevated global risks and likely return of inflation.
“Inflation has come off from its peak, but its further downward movement is going to be slow and gradual,” RBI said, dousing expectations of aggressive rate cuts.
Inflation, as measured by wholesale prices, dropped to 7.18% in December, giving the RBI room to cut rates and infuse liquidity in the banking system.
Mohan Shenoi, treasurer at Kotak Mahindra Bank Ltd, said the current spike in CD rates resembles the March-end rush by banks to garner deposits because financial institutions like to stay “liquid” in the last fortnight of the financial year.
“It looks like a temporary spike but it’s just that it has happened quicker than normal. I don’t expect it to continue beyond March because the CRR (cash reserve ratio) cut is yet to take effect and we are expecting RBI to cut rates by another 25 to 50 basis points (bps) in 2013,” Shenoi said. Banks’ daily borrowings from RBI have been pointing towards improvement in liquidity, he added.
One bps is one hundredth of a percentage point.
The CRR cut will infuse Rs.18,000 crore in the banking system from the fortnight beginning Saturday, 9 February.
Banks have borrowed an average of Rs.88,375 crore in the current reporting fortnight which ends on Friday, down from Rs.91,748 crore average borrowing in the fortnight ended 25 January.
On Wednesday, banks borrowed Rs.56,115 crore after borrowing on average at least Rs.1 trillion daily last week.
N.S. Venkatesh, head of treasury at IDBI Bank Ltd, said the higher rates banks are paying on CDs could be a result of the current wedge between deposit and credit growth.
Deposit growth at 13.08% is much lower than the 16.05% credit growth in the banking system, according to data from RBI as on 25 January.
“Only short-term rates are higher. Banks must be borrowing short-term because lending picks up in the year-end as some companies choose to borrow short-term loans at the year-end,” Venkatesh said.
Venkatesh also expects CD rates to ease by April as liquidity improves and RBI continues to cut rates.