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Cash Drain

An unexpected CRR hike saw the market concede its gains of the past week. Consequently tightening liquidity governed sentiment

There was disappointment in the government bond markets. No one expected the central bank to increase the Cash Reserve Ratio (CRR) on its scheduled policy review on Tuesday. In fact there were some who were exceedingly optimistic, hoping for a possible reduction in key lending rates. The RBI raised the CRR by 50 basis points to 7.50 per cent effective November 10. This will see a drain of close to Rs 16,000 crore.

Consequently the yield on the 10 year benchmark 7.99 per cent GOI 2017 rose by four basis points to close at 7.86 per cent on Tuesday, October 30. But there was some recourse for the market with the US Fed Reserve meeting expectations and lowering its key lending rates. This in turn brought relief to the market as the Federal Reserve's move is likely to bring in more money into the system. The CRR hike to some extent will help curtail the impact of more inflows. The Federal Reserve's move was more or less discounted in bond prices; nevertheless the yield on the benchmark bond fell by one basis point.

Apart from the CRR, the cash drain for the forthcoming week looks like this: Rs 8,000 crore of dated securities on November 8, Rs 3000 crore of 364 day T-bills and another Rs 3500 crore auction of 91 day T-bills.

While annual inflation as of October 20 stood at 3.02 per cent, lower than the previous week's 3.07 per cent, increasing oil prices wiped out the cheer from lower inflation. On Friday the benchmark bond finally closed at 7.85 per cent, up three basis points since its previous close.

The past week was significant in determining the near term outlook for the bond market. The RBI Governor's statement that inflation and growth are under control and liquidity remains the only problem area was encouraging. It remains to be seen whether the governor will resort to another CRR hike at the end of January or will he raise the cap on the market stabilisation scheme (MSS). Both initiatives will not be received well by the bond market. Of course if inflows do indeed slow down the RBI will be less stressed and may even consider a downward revision in key lending rates.

Another important comment was by the US Federal Open Market committee which said “upside risks to inflation balanced downside risks to growth”. The statement led to the view that the Federal Reserve will not reduce rates any further. This in turn will help the RBI to keep its key lending rates unchanged. The writing on the wall is clear, in the near term a downward revision of RBI's key lending rates is highly unlikely.

Outlook
The week ahead doesn't look too bright for the bond market. The market is likely to react severely on Monday to the cumulative Rs 14,500 crore bond auction announced by RBI on Friday. Sentiment will hinge on movement of oil prices. Further the market will lack luster owing to a possible liquidity crunch, given a total mop up of Rs 20500 crore during the forthcoming week.