Mumbai: The bond market had a dull year, although there were some minor scares on the liquidity front, especially in March. But the central bank, which kept interest rates unchanged for the most part, ensured that there was enough cash in the system through cuts in the cash reserve ratio (CRR) and open market operations (OMOs). Debt market sentiment improved at the fag end of the year amid what looked like the end of a policy logjam and the central bank all but promising interest rate cuts next year.
CRR is the portion of deposits that commercial banks need to keep with the central bank on which they do not earn any interest. OMOs refer to the buying of bonds by the central bank in the secondary market to infuse cash in the system.
In a tight liquidity scenario, the year started with a steep inverted yield curve with short-term treasury bill rates being higher than the rates of longer-term papers. On 2 January, the yield on the three-month treasury bill was 8.47% against 8.4% on the 10-year bond. By 17 February, the yield on the three-month treasury bill had shot up to 8.92% while 10-year paper yield dropped to 8.19%, distorting the yield curve into a deep inversion, in other words, an unusually wide variation.
Even as liquidity pressures eased marginally, short-term rates remained elevated for the most part of the year before easing in August. However, in December, short-term rates started rising again with banks borrowing heavily from the Reserve Bank of India (RBI). On Wednesday, banks borrowed Rs.1.36 trillion from RBI.
The yield curve—an interest rate curve plotted across tenures—is not normal as yet, but it is getting flatter.
Factors such as lower credit offtake and the expectation of rate cuts by RBI have helped in keeping a check on short-term rates. But if credit growth picks up pace, the yield curve will in all likelihood again get distorted, say bond dealers. However, they don’t expect credit growth to pick up considerably from the present level. Till November-end, the banking system’s growth in credit offtake was 17% from a year earlier.
RBI cut its policy rate by half a percentage point in April to 8%, but refrained from further cuts as inflation continued to remain high in Asia’s third largest economy, above the central bank’s comfort level. The government’s policy changes that began in September rekindled hopes of a rate cut in October and December, but the central bank held rates while holding the prospect of cuts next year.
The fact that the government plans to borrow a record Rs.5.71 trillion in the fiscal year ending March didn’t dampen demand for bonds. Banks continued to invest heavily in government debt in the absence of alternative avenues in which to deploy funds. They have now invested more than 30% of their deposits in government bonds against the mandatory requirement of 23%. The excess is used as security on borrowings from RBI.
This is also the reason why overnight call money rates in the interbank money market never shot up barring a few days in March. On 30 March, the close of fiscal year 2011-12, banks borrowed a record Rs.2 trillion of overnight money from RBI, a reflection of the liquidity squeeze at the time as importers scrambled to pay off their dues and companies paid advance taxes.
For about three days at the end of that month, call money rates shot up to 15%, but soon came down to 7.5% as the new fiscal year began. Call money is expected to range between 8% (the repo rate) and 7% (the reverse repo rate). The repo rate is that at which the central bank infuses liquidity in the system; it’s drained at the reverse repo rate.
“Bond yields throughout the year largely remained range bound. That is because the market’s expectation of rate cuts did not match with the actual action by the Reserve Bank,” said Vivek Mhatre, head of treasury at Union Bank of India.
“However, the hope for rate cuts is very strong and starting the second week of January, the liquidity scenario will ease. Inflation should ease and bond yields should fall by at least 20-25 basis points,” said Mhatre. A basis point is one-hundredth of a percentage point.
Corporate bond yields largely mirrored the gilts market—an inversion in yield curve was seen there as well. Firms queued up to raise money through debt in the absence of cuts in bank lending rates.
Between January and 15 November, companies issued bonds worth about Rs.2 trillion against Rs.1.53 trillion in the year-ago period, according to RBI data.
The highest rate at which these bonds were issued touched 14.5%, the same as in 2011, while the lowest was 7.64%, against 6.6% last year.
“In the beginning of the year, the corporate bond yield curve was inverted. This was an anomaly. It corrected and overall, corporate bond yields came down. Now the corporate bond yield curve is flat. We expect further correction next year,” said Joydeep Sen, vice-president at the advisory desk of BNP Paribas Wealth Management.