Mumbai: India’s inter-bank rates are extending the biggest drop in six months as Reserve Bank of India (RBI) governor Raghuram Rajan adds cash to the financial system for longer periods.

The three-month rate fell to 9.21% on 2 May after sliding 54 basis points in April to 9.23%, the National Stock Exchange (NSE) data show. A similar gauge in China is at 5.48%. RBI added about 1.41 trillion ($23 billion) last month through repurchase contracts of up to two weeks, while reducing overnight offerings.

The policy shift in favour of so-called term repos is helping drive down funding costs as Rajan seeks to spur lending and economic growth while refraining from cutting the RBI’s benchmark rate to curb inflation. Cash availability is allowing banks to increase investments in sovereign bonds to a record, even as global funds reduce holdings and the government embarks on its annual borrowing programme.

“Term repos have led to a more stable liquidity regime in the markets, helping investors become more efficient," said Debendra Kumar Dash, a fixed-income trader at DCB Bank Ltd in Mumbai in a 2 May phone interview. “Liquidity is the life-blood of bond markets."

The yield on the benchmark 10-year note has slumped 29 basis points, or 0.29 percentage point, from a four-month high of 9.1% on 7 April. It had risen on concern that supply of debt will increase after the government started its 5.97 trillion borrowing plan for the year through March 2015.

Bond holdings

Holdings of sovereign bonds by Indian commercial banks rose to an unprecedented 22.71 trillion as of 18 April, according to the latest RBI data.

Local lenders are buying bonds even as foreign investors pare investments in rupee-denominated corporate and government debt to avoid losses should national elections ending this month fail to deliver a clear winner. Global funds sold a net $1.85 billion of bonds in April, the first outflow in five months, exchange data compiled by Bloomberg show.

“The central bank has been managing liquidity well through the term repos," said Jayesh Mehta, Mumbai-based managing director and country treasurer at the Indian unit of Bank of America Merrill Lynch, in an 30 April email interview. “That has contributed to the drop in government bond yields."

The RBI is progressively reducing cash offerings via overnight repos while increasing injections through term contracts, Rajan said in his 1 April monetary policy statement. Lenders’ overnight borrowings from the RBI averaged 12,250 crore last month compared with 23,400 crore in March, official figures show.

Policy transmission

“The primary objective is to improve the transmission of policy impulses across the interest rate spectrum," Rajan said. The term repo allows market participants to hold liquidity for a longer period, thereby providing the impetus for engaging in term transactions in the market, evolving market-based benchmarks for pricing various financial products and also improving efficiency in cash and treasury management.

Banks are buying more government debt because a seasonal slow down in credit demand and recent repayments of bonds upon maturity have left them with excess cash, according to IDBI Bank Ltd. Lending typically slows in the April-June period as companies use first quarter of the fiscal year to draw up their investment plans.

“Banks have ample liquidity as credit growth doesn’t really take off in the first quarter," N.S. Venkatesh, IDBI’s head of treasury in Mumbai, said in an 30 April phone interview. “Hence, lenders are investing in government securities."

Bank lending

Bank advances increased 14.3% from a year earlier as of 18 April after the pace had slowed to 13.8% as of 4 April, the central bank data show. Lending growth was at 13.7% in June, the lowest since December 2009.

Rajan kept the RBI’s repurchase rate (repo rate) unchanged at 8% last month to support growth before national polls that started 7 April and will end 12 May, with results due 16 May. He increased the rate by 75 basis points since taking office in September to curb the fastest consumer-price gains among Asia’s major economies.

India expanded 4.5% in the year through March 2013, the slowest pace in a decade. The government estimates gross domestic product (GDP) increased 4.9% in the year ended 31 March.

Government borrowing

Finance minister P. Chidambaram in February’s interim budget announced gross borrowing for the fiscal year that began 1 April, which was higher than a revised 5.64 trillion for the prior period. The administration estimates that some 62% of this year’s total target may be met in the April-September period. The budget provided funds for until a new parliament is elected.

The biggest constraint for the new government will be raising revenue, Chidambaram said in a March interview to a local newspaper. India needs higher economic growth to fund for spending, and the government should avoid increasing borrowings in the absence of revenues, he said.

The yield on the 8.83% sovereign bonds due November 2023 fell 8 basis points last week to 8.81%, prices from the central bank’s trading system show. That’s the lowest since 28 March. The rupee climbed 0.8% to 60.1625 per dollar in the same period and has advanced 2.7% in 2014.

“The currency’s strength and the central bank’s liquidity support through term repos are aiding sentiment," Harish Agarwal, a fixed-income trader in Mumbai at FirstRand Ltd, said in a 2 May telephone interview. “What needs to be seen is for how long the central bank provides these cash injections." Bloomberg