Mumbai: Expectations of an interest rate cut by the Reserve Bank of India (RBI) and hope that the government will not need to borrow more than what is budgeted in the current fiscal year have pulled down bond yields sharply.
The yield on benchmark 10-year—8.15% paper due June 2022—bond eased to 7.97% on Thursday, its lowest level since April 2011, and down from 8.97% in November.
Bond dealers expect yields to trend lower to at least 7.8% this month before RBI announces its third quarter policy review on 29 January.
N.S. Venkatesh, head of treasury at IDBI Bank Ltd, said RBI’s mid-quarter statement in December which clearly mentioned the shift in the central bank’s priority from inflation to growth has led to the drop in bond yields.
“In view of inflation pressures ebbing, monetary policy has to increasingly shift focus and respond to the threats to growth from this point onwards,” RBI had said in December, while reiterating its October guidance that had talked about easing of rates in the fourth quarter of the fiscal.
“Besides rates, expectations are also that the government borrowing will stay within budget this year and any additional borrowing will only be done through short-term treasury Bills. Demand for bonds will also come from foreign funds which have bid for buying $2 billion worth of government securities...All these factors are contributing to the demand for bonds,” Venkatesh said.
Rs.12,000 crore from the week ending 4 January to the week ending 22 February, because of the large cash balance it has maintained with the RBI.
The government kept Rs.90,000 crore with RBI as of 21 December.
The Indian central bank has also been infusing liquidity in the banking system through regular purchases of government securities. So far in the current fiscal year, the RBI has purchased at least Rs.1.1 trillion of government bonds through the so-called open market operations (OMOs).
Ananth Narayan, regional head, fixed income, currencies and commodities South Asia at Standard Chartered Bank, said the fact that inflation has also come off has improved sentiment.
Wholesale price inflation slowed to 7.24% in November from 9.46% a year ago. It was 7.45% in October.
“Inflation has been coming off for a couple of months now and the OMOs are also ensuring that there is enough liquidity in the market. The government is likely to complete its borrowing within budget which has also helped sentiment,” Narayan said.
The government planned to borrow Rs.5.7 trillion this year and Rs.3.5 trillion had been raised in the first half of the fiscal year that ended in September. Narayan, however, said that the huge cash balance does not mean that the government will reduce its borrowing.
“The cash balance is probably because of a mismatch but the government will surely start spending soon and that balance will disappear,” he said.
However, the postponement of the auction earlier this week has increased expectations that the government will not overshoot its budgeted borrowing.
“The postponement of the auction is a signal that the government is on the right fiscal path, which in itself is a positive. The chances of extra borrowing is also low which is also a positive,” said Hitendra Dave, head of global markets India at Hong Kong and Shanghai Banking Corp. Ltd (HSBC).
However, the lower yields are not translating into lower lending rates by banks. Only HDFC Bank Ltd, the country’s second-largest private sector bank, has reduced its minimum lending rate, or base rate, by 10 basis points (bps) to 9.7% effective Monday. One basis point is one-hundredth of a percentage point.
Bankers are waiting for a rate cut from RBI before moving to easing rates. ICICI Bank Ltd and State Bank of India are yet to take a call on lending rates.
Paresh Sukthankar, executive director at HDFC Bank, said the bank adjusted its lending rates, based on its internal liquidity and cost of funds and not pre-empting an RBI rate cut.
“We review our rates every quarter and this change has been a cumulative impact of our deposit rate cuts and also the reduction of the cash reserve ratio by RBI,” Sukthankar said.
The cost of other money market instruments such as commercial paper (CP) and certificate of deposits (CD), too, has dropped. The one-year CP rate has come down to 9.3% from 11.3% in March 2012. Similarly, one-year CD has declined to 8.66% from 10.95% in March 2012.
The fall in the yields could help public sector banks gain through increased treasury income. “All public sector banks are likely to gain because they mostly hold long duration maturities unlike private banks. They are likely to benefit by the higher prices this time,” said Nilanjan Karfa, an analyst at Brics Securities Ltd.