Bond redemptions, govt spending to ease crunch

Bond redemptions, govt spending to ease crunch

Mumbai: A combination of higher government spending, redemptions of bonds and better deposit mobilization by banks offering higher interest rates is expected to improve liquidity in banking system in the March quarter and reduce the bond market’s dependence on liquidity support from the Reserve Bank of India (RBI), analysts said a day before the RBI holds the last of its four-phase 48,000 crore bond buyback programme on Wednesday.

The bond buy-back programme was introduced in December to provide liquidity to tide over the cash crunch in the wake of large advance tax payments and equity outflow from large initial and follow-on public offerings such as the 14,970.20 crore one from Coal India Ltd. Besides, the government’s reluctance to spend also added to the tightness.

A Prasanna, senior vice-president, ICICI Securities Primary Dealership Ltd, a firm that buys and sells government bonds, said liquidity has improved in the last two weeks, pointing out that banks borrowed an average of 60,000 -65,000 crore daily from the central bank in the last week against around 1-1.6 trillion daily in three months between October and December 2010.

“With expected government spending in March and bond redemptions in January-February, we expect the bond market will likely be comfortable this quarter," Prasanna added.

The government was sitting on a cash balance of 1.50 trillion on 31 December, which it is expected to spend before the end of the fiscal year in March, according to Deepali Bhargava, economist at ING Vysya Bank Ltd.

Bonds worth 19,000 crore are also awaiting redemption, in two tranches. The first such redemption will take place in end of January and the second in end of February.

“Rise in government spending and a drop in currency circulation will support gradual improvement of liquidity," Bhargava said.

Currency in circulation or currency with the public rose by 60,000 crore in two months, she said. Since this money is not kept with banks, it does not add to the liquidity in the system. Typically, during festivals people tend to keep money in the wallet to spend.

Bhargava expects December’s headline inflation to rise to 8.4%, from 7.48% in November. The latest inflation data is expected on Friday.

However, more money in the system is unlikely to lead to a massive improvement in bond market sentiment because of a likely interest rate hike by RBI in its third quarter monetary policy review on 25 January.

Once this happens, bond prices will drop and yields will rise. The yield on 2020 benchmark government bond closed at 8.21% on Tuesday, lower than Monday’s 8.26% closing, its eight-month high, according to data from Clearing Corp. of India Ltd’s website.

Bond yields have been rising in past few days due to inflation worries and expectations of key policy rate hikes on RBI’s policy review meeting.

“The downward pressure on the bond market may continue till the (expectations of) a rate hike are over (at the RBI policy meeting on 25 January). Bonds will be bearish due to volatile equities impacting the bond market and the lack of positive macroeconomic triggers," said G.A. Tadas, managing director and CEO of IDBI Gilts Ltd, a primary dealer.

RBI is expected to hike repo rates—the rate at which it lends to banks—by 25 basis points to 6.5%, to fight inflation. One basis point is one-hundredth of a percentage point.

Tadas also said deposit rate hikes by banks will support bank fund mobilization and, hence, improve liquidity.

Samiran Chakraborty, chief economist at Standard Chartered Bank Plc, expects RBI to hike rates by 25 basis points in January and by an identical margin in March as well.

“The 10-year benchmark may touch 8.5% yield levels by March end," he said. Chakraborty expects liquidity may improve by March end.

RBI has raised its key policy rate five times in 2010 but left it untouched in its December review of monetary policy.