Short-term borrowing costs fall as liquidity eases
3 min read.Updated: 06 Jul 2016, 04:20 AM ISTIra Dugal
Easier liquidity conditions, expectations that the next RBI governor could be softer on inflation and a drop in global bond yields have pulled down borrowing rates
Mumbai: The costs at which the government and local firms are borrowing short-term money from the markets are near five-year lows and set to fall further as the Reserve Bank of India’s (RBI’s) decision to infuse cash into the system starts to pay off.
Easier liquidity conditions, expectations that the next RBI governor could be softer on inflation and a drop in global bond yields have together pulled down the prevailing borrowing rates in the market.
On Tuesday, the government sold 91-day treasury bills (T-bills) at a coupon rate of 6.60%—the lowest since 13 October 2010. The 91-day T-bill tends to act as a benchmark for short-term borrowing costs. The 91-day T-bill rates have fallen over 20 basis points (bps) in the last month alone.
As such, companies borrowing short-term funds through 3-month commercial papers have also seen borrowing costs drop. The yield on 3-month commercial paper closed at 7.82% on Tuesday, having fallen about 13 bps over the past one month. One bps is one-hundredth of a percentage point.
“A large part of the move lower on short-term rates has been because of the easier liquidity conditions in the market," said Manish Wadhawan, managing director and head of interest rates, HSBC India. Wadhawan points out that RBI has infused nearly ₹ 80,000 crore into the system through open-market operations in the first quarter of the current fiscal year, in addition to interventions in the foreign exchange market.
As a consequence of the improved liquidity conditions, interest from banks towards investing in T-bills has risen, while strong demand has also been seen from mutual funds, Wadhawan said.
“This is a liquidity-based trade," he said, adding that rates may fall a little further if current conditions continue.
In its 5 April policy, RBI said that it would move away from its policy of maintaining a liquidity deficit and infuse cash into the system. The central bank said its intention was to improve transmission of lower policy rates which have been reduced to 6.5% from 8% at the start of 2015. An indication that RBI’s objective of maintaining neutral liquidity has been achieved is the funds that banks are now parking with RBI. On Saturday, banks parked more than ₹ 60,000 crore with the central bank through RBI’s reverse repo window.
Longer term bond yields have also slipped.
The benchmark 10-year bond yield fell to 7.39% on Tuesday—a level last seen on 20 June 2013. The 10-year yields have fallen in 12 out of the last 16 trading sessions and have declined about 8 basis points over the past month.
While liquidity has played a role in the decline in long-term borrowing costs as well, the more dominant factor in this case is the decline in global bond yields and a growing expectation in the market that the new RBI governor may be more open to reducing rates further.
“There has been a softening of global bond yields and India is reacting to this. In addition, there is a build-up of expectations that the incoming RBI governor may be more dovish," said R. Sivakumar, head of fixed income at Axis Mutual Fund. He added that as the monsoon gathers pace, concerns over a resurgence in food inflation are also easing.
“The 10-year yield could move into a range of 7-7.25% even with the current expectations of consumer price inflation stabilizing between 5-5.25%," said Sivakumar. Retail inflation quickened to 5.76% in May, the highest in 21 months and well above RBI’s target of 5% consumer inflation by March 2017.
The fall in Indian yields is in line with the drop in global yields. Yields across most major economies fell as investors sought the safety of government bonds after Britain voted to exit the European Union on 23 June. As investors piled into bonds, prices have risen and yields have declined. Bond yields move inversely to bond prices.
In early US trades on Tuesday, the 10-year bond yield fell to a record low of 1.38%. Germany’s 10-year benchmark yield has also fallen steeply since the Brexit vote and moved into negative territory.
“Brexit has been a turning point for the markets. Investors are uncertain whether this will end up being a mini-Lehman like situation and hence have sought the safety of bonds," said Wadhawan, pointing out that even riskier assets such as equities have rallied because investors expect central banks to step in and take action if global market volatility picks up again or if economic conditions worsen.