First Quarter Review of Monetary Policy 2011-12 - RBI stumps with 50-bps hike; Inflation target hiked to 7%

The RBI revealed its super hawkish monetary policy for the first quarter 2011-12 by raising the policy repo rate under the liquidity adjustment facility (LAF) by 50 bps.  The repo rate will now move to 8 per cent. This is 11^th successive hike since Mar 2010 and the fastest monetary accommodative uncovering in the world. Consequently, the reverse repo rate under the LAF, at a spread of repo rate minus 100 bps gets adjusted to 7 per cent. Similarly, the Marginal Standing Facility (MSF), determined at a spread of 100 bps above the repo rate will move up to 9 per cent.

Repo rate is the rate at which RBI lends to banks and Reverse repo rate is the rate at which RBI borrows from banks. The new term Marginal Standing Facility (MSF) is the additional borrowing window for banks set up at 100 bps above repo rate and they can borrow overnight up to one per cent of their respective Net Demand and Time Liabilities (NDTL).

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Nov 02 policy review eyed

Highlights:

• Amid tight systematic liquidity, the RBI announced a special second LAF, a liquidity window for scheduled commercial banks to borrow to the extent of up to 1.0 per cent of their Net Demand and Time Liabilities (NDTL) as on Oct 08 on all days during Oct 29-Nov 04, 2010. The RBI also announced a special 2-day repo auction under the LAF on Oct 30, 2010 which saw a total borrowing of Rs. 11,025 crore under LAF. The RBI also allowed waiver of penal interest, if any for any shortfall in maintenance of SLR on Oct 30-31, 2010 out of these special facilities.

• The buy-back programme as announced by the government did not draw good responses from the market – with bids worth Rs. 3,174 crore tendered against the notified amount of Rs. 12,000 crore. However, the total amount accepted for buy-back was Rs. 2,148 crore only.

• The benchmark bond seemed to lose its appetite after volume shifted to 8.13% G-Sec 2022 as the market expected that 7.80% G-Sec 2020 may not see any auctions further. However, comments from a Finance Ministry official who hinted that the 10-year bond will retain its benchmark status till fiscal year end led to a swift rally in it. Further, the RBI’s special liquidity window led to fall in yields. The 10-year benchmark paper closed at 8.11, down by 3 bps over the week.

• India’s primary articles’ inflation fell to 16.62 per cent in the week ended Oct 16 from 18.05 per cent in the last week while food articles’ inflation fell to a 50-week low of 13.75 per cent from 15.53 per cent a week before.

• Growth in India’s key infrastructure industries, which constitute 26 per cent of IIP figures fell to a 19-month low of 2.5 per cent in Sept compared to 3.9 per cent and 4.3 per cent in Aug and a year ago respectively.

View & Recommendations:

• The special liquidity window announced by RBI may ease the structural liquidity crisis. The RBI is looking to normalize policy rates given high inflation; however, it feared that the QE-II (Quantitative Easing 2 to be announced by Fed Reserve) may bring more capital inflows into the system which will force the RBI to contain the rupee appreciation. This may lead to inflation hike further.

• The market participants have expected a hike of 25 bps in policy rates to be announced by RBI on Nov 02. The market has already factored into the 25 bps hike in policy rates. So, yields might not move significantly if there is hike in policy rates. However, the government may decide to cancel the auction after which the government bonds may witness a rally.


Broader Perspectives:

Bond Front

The buy-back programme announced by RBI did not draw strong interests from market participants. Bids worth Rs. 3,174 crore were tendered against the notified amount of Rs. 12,000 crore. However, the total amount accepted for buy-back was Rs. 2,148 crore. The securities which are bought back are 8.75% G-Sec 2010, 12.32% G-Sec 2011 and 6.57% G-Sec 2011 for notified amount of Rs. 28.97 crore, Rs. 616.35 crore and Rs. 1,502.97 crore respectively. The inflation continued to remain in uncomfortable zone which may allow the central bank to use all its ammunitions, policy rate hikes being the most prominent one. The RBI policy will be announced just before the much awaited US Federal Reserve announcement regarding the much touted QE-II, or second round of quantitative easing. The probability goes high as the US jobless rate hovered around 10 per cent for a third month in October.

The benchmark yield kept on spiraling and touched its near months high of 8.18 per cent. Meanwhile, the borrowing limit in benchmark bond saw a shift in active trading to other yields. The 10-year benchmark paper closed at 8.11 per cent, down by 3 bps. The 8.13% G-Sec 2022 became the most actively traded securities during the last week.

The tight liquidity scenario, an example of structural liquidity deficit led to a hike in interbank call money markets which rose as high as 12 per cent. During the week, the banks borrowed a net amount of Rs. 4.80 lakh crore against the previous week of Rs. 3.17 lakh crore. The Repo and CBLO rate closed at 6.43 per cent and 7.96 per cent, an increase by 72 bps and 261 bps respectively.

The 1/10 year G-Sec spreads fell to 112 bps from 124 bps a week earlier. And the average G-Sec volume reported was Rs. 47,412 crore compared to Rs. 53,776 crore a week earlier.

Bond Supply

The market didn’t have any central government auctions scheduled for this week; however, the SDL (State Development Loans) auctions raised Rs. 8,601.8 crore as against the notified amount of Rs. 8,226.8 crore with the state of Tamil Nadu exercising the green show option to the tune of Rs. 375 crore.

Liquidity

The systematic liquidity remained in deficit mode which allowed RBI to open an additional liquidity window. The liquidity as measured by bids for reverse repo/repo in the LAF (Liquidity Adjustment Facility) auction of the RBI reported a net borrowing of Rs. 4,80,180 crore or daily average of Rs. 80,030 crore.

Corporate Bonds

The corporate bond yields saw a hike in the concluding week. The 10-year AAA bond ended at a yield of around 8.80 per cent compared to 8.76 per cent in the previous week. Credit spreads moved up with 5-year AAA spreads moving up by a basis point to 69 bps levels.

Source: MOSL

Domestic bond yields take cues from US, UK

Highlights:
• Ten year benchmark bond 7.80 per cent 2020 closed at 7.49 per cent touching its Dec figures, down by 15 bps from 7.64 per cent reported last week
• US $ 1 trillion EURO and IMF rescue package to Euro-Zone failed to cheer the world market post announcement
• Flight to Safety witnessed where the money moved out of emerging markets and fled back to US, UK and Germany bonds; yields touched their six-month lows
• India’s headline inflation as measured by Wholesale Price index (WPI) eased to 9.59 per cent in April from 9.9 per cent a month ago
• Liquidity traded at a daily average level of Rs. 28,749 crore
• Income category funds saw an inflow of Rs. 1,77,773 lakh crore in April as compare to an outflow of Rs. 1,64,487 crore as per the data released by AMFI

View &Recommendation:
• Bond yields continue to move down tracking the spurt in buying of US, UK and Germany bonds. The Euro crisis failed to settle down even after the announcement of a rescue package of US $ 1 trillion by other European Union and IMF. The shock waves sent by Euro zone are affecting the currency markets which may lead to a fall in EURO. Equity markets too fall in line with all major world indices going southwards.
• Looking forward, the lower end of the yield curve will continue to trade in range bound. However, in long term, the bond yields may witness upward revisions due to continuous supply of papers.
• The top recommended funds in Ultra Short Term category (erstwhile called as Liquid-Plus Funds) are IDFC Money Manager – Invest Plan – Plan A, HDFC Cash Management Fund – Treasury Advantage and Kotak Floater Fund while in Liquid Fund category, the recommended schemes are HDFC Cash Management Fund – Savings Plan and Reliance Liquidity Fund.

Broader Perspectives:
Though India’s headline inflation figure based on Wholesale Price Index (WPI) narrowed to 9.59 per cent in April from 9.90 per cent a month ago, the government continues to worry from the high figures. The Chief Economic Advisor says that Inflation will continue to fluctuate over the next three months before it starts falling steadily. The WPI topped the 10 per cent mark for the first time in 15 months in February. The higher than the expected inflation put upward pressure on yields. The Industrial Output data as measured by Index of Industrial Production (IIP) slid to 13.5 per cent in March against the market expectation of 15 per cent; manufacturing output grew 14.3 per cent in March compared with 16.1 per cent in February.
The benchmark bond 7.80 per cent 2020 yield dropped below 7.50 per cent level. It closed at 7.49 per cent touching its December figures, down by 15 bps from 7.64 per cent. The G-Sec spread of 10-5 years maturity bonds narrowed to 23 basis points from 27 bps a fortnight earlier. However, the 5-1 year spread widened to 214 bps from 165 bps reported last fortnight. G-Secs rallied following a fall in US Treasury yields, lower IIP and WPI figures. The most traded G-Sec 8.20 per cent 2022 saw yield falling to 7.74 per cent, down by 11 bps. The higher than the expected revenue from 3G auctions will help reducing the high borrowing program. The government is expected to raise Rs. 50,000 crore as against the expected figures of Rs. 35,000 crore. If 2G recommendations as suggested TRAI are implicated by the Telecom Ministry, the government will add additional revenue to its chest. The government issued Cash Management Bills of worth Rs. 6,000 crore at a cut-off yield of 3.87 per cent to pay off its bond redemptions.

The week saw an auction worth Rs. 12,000 crore of Government Securities namely 6.85% G-Sec 2012 (Re-issue), 6.35% G-Sec 2020 (Re-issue) and 8.26% G-Sec 2027 (Re-issue) for a notified amount of Rs. 5,000 crore, Rs. 5,000 crore and Rs. 2,000 crore respectively. All the securities were auctioned off successfully at cut-off yields of 7.24 per cent, 7.54 per cent and 8.22 per cent. There was no devolvement to Primary Dealers. However, the appetite among bond buyers seems to be dampened as the bid to cover ratio slipped below 2X despite a strong bond rally. The 10-year benchmark paper was subscribed to an extent of 1.58 times only. However, there was a strong demand on shorter tenure paper. The bond 6.85% 2012 was subscribed by around 3 times.
Liquidity as measured by bids for reverse repo/repo in the LAF (Liquidity Adjustment Facility) averaged Rs. 28,749 crore against last week average of Rs. 55,491 crore. Banks were also reluctant to lend to each other following weak credit sentiment in the market. The average Call and CBLO rate increased to 3.79 per cent and 3.68 per cent from 3.74 per cent and 3.32 per cent reported last week.

Yields to reel under inflationary pressures; rate hikes imminent

Highlights:

• Government borrowing schedule of massive Rs. 4.57 lakh crore declared; 63 per cent of total borrowings are front-loaded in first half of fiscal year 2010-11.


• On an average, the weekly borrowing would be in the range of Rs. 11,000 to Rs. 13,000 crore; the May month may witness the maximum borrowing of Rs. 65,000 crore with minimal borrowing of Rs. 22,000 crore in September.


• No Open Market Operations (OMOs) transactions declared; unlikely to put any pressure on yields due to sufficient liquidity.


• The week saw a sudden yearend decline in bond yields following the borrowing schedule declaration; unlikely to sustain the spurt in bond prices.


• Inflationary pressures to continue putting pressures on bond yields.


• The 10-year benchmark G-Sec 6.35 % 2020 to trade in the range of 8-8.5 per cent for most of the year.


• There was a combined transaction of Rs. 9,540 crore under Repo Facility in the last 3 days of Fiscal Year 2009-10.


• The G-Sec spread between 1-5 years have widened to 238 bps from 227 bps in the previous week.

Views & Recommendation:

·         For few weeks, the market may absorb the bond issuances without any impact on yields but in long term, the bond yields may witness upward revisions.

·         The short-tenure bonds would be in demand in the month of April and May in the current fiscal year due to negligible issuances. This may lead to unexpected hike in prices of short to medium term papers. An opportunity lies ahead in booking profits in short-to-medium term bonds/Income Funds/Short Gilt Funds after a couple of months.

On return basis, Tata G S S M F – Growth (6.67%), UTI G Sec Fund – STP – Growth (5.06%) among others has been front runners under Short-term Gilt Funds in two-year category. 

·         Liquid Funds and Ultra-Short term Debt Funds (erstwhile called as Liquid-Plus Funds) will continue to see inflows as investors would continue putting their surpluses for a short duration.

Broader Perspective:

The market reacted positively on the announcement of Government Borrowing Schedule; about 63 per cent of total borrowings (Rs. 2.87 lakh crore) are front-loaded in the first half of fiscal year 2010-11. Thus, it would prevent crowding out for private firms as post-October used to be busy borrowing month for them. The market will see an average weekly auction of Rs. 11,000 – Rs. 13,000 crore. The benchmark bond 6.35 per cent 2010 yield saw some swings.  The yield fell from 7.85 per cent to as low as 7.74 per cent before closing at 7.85 per cent level again. The 10-year benchmark G-Sec price closed at Rs. 89.90 down from Rs. 90.30 level as on Mar 30, 2010. Bond Prices and Yields move in opposite direction.

The high inflationary pressure is on the top agenda of policy makers as they are closely scrutinizing to negate its effects on yields since it would increase their borrowing costs. The inflation as measured by Wholesale Price Index (WPI) has already touched 9.89 per cent for the month of Feb 2010 and the March figures may touch the double digit. Though the government officials are of the view that inflation would drop down in couple of months citing the high base effect and falling food prices as the prominent reasons, it will continue haunting on non-food sides. The high crude prices including the high petrol and diesel prices for EURO IV vehicles will add pressures to inflation further.

The market may factor into the weekly bond supply and will see a smooth transition of bonds for first few weeks but the yields may harden in the weeks to come citing the absence of any Open Market Operations (OMOs) from the government side.

The other bonds 7.02% 2016 and 7.32% 2014 saw yields moving up 13 bps and 1 bps to 7.59 per cent and 7.25 per cent levels. Corporate bonds also saw yields dropping down. The shorter end of the curve saw yields falling piercingly after March-end liquidity worries went out of the system. The last three days of the fiscal year 2009-10 saw a total repo transaction of Rs. 9,540 crore under Liquidity Adjustment Facility (LAF). The liquidity as measured by Reverse Repo transaction under Liquidity Adjustment Facility (LAF) remained tight with an average volume of Rs. 4,027 crore.