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Provoking A Sell-off

Credit Policy failed to excite the bond market as the bank rate cut didn't materialise and the CRR cut was below market expectation. As a result, the yield on the 10-year benchmark climbed to 7.4%, closing at 7.54% on Friday.

This was a rather lackadaisical week for bonds. In a nutshell, first credit policy and then a steep rise in call rates saw bonds tripping throughout the week. With the much-expected bank rate cut not coming about, and only a 50-basis point cut in CRR, it send the yield on the 10-year benchmark (11.03%, 2012) on an upward journey, to 7.40%, as against last Friday's closing of 7.29%. Since some banks fell short of their reserve needs on reporting Friday, there was a high demand for funds in the call market. This led to call rates hitting the roof (an intra-day high of 8.40% on Friday), which forced market players to indulge in gilt selling. The result: gilt prices fell by 50-60 paisa across-the-board. Consequently, the yield on the benchmark closed at 7.54% on Friday – up 25 basis point over the week.

On Thursday, the Reserve Bank auctioned the 10-year bond worth Rs 6,000 crore at the cut-off yield of 7.4%. With this, the government completed 13% of its targeted borrowing programme for the fiscal. The temporary shortfall in funds was attributed to the auction, which further hurt gilt prices on Friday.

On the call money front, the call rates remained in the 6.35-6.55% band till Thursday. However, it zoomed to a high 8.4% on Friday before closing at the 8-8.25% level as banks ran for cover to maintain CRR before the reporting Friday.

As for the rupee, it ended the week at 48.97 to a dollar – unchanged since last Friday. It held its ground mid-week (48.95) backed by steady dollar inflows from exporters and non-residents. But it again turned weak on Friday due to heavy dollar buying by state-run banks. The market is anticipating that if dollar demand continues to remain stronger next week the rupee could fall to its all-time low of Rs 49.06.

Let us now move to the credit policy and its resultant impact on the bond market. Bringing down the CRR by 50 basis point was in line with the objective of reducing CRR to 3% in phases. But the market expected that a calendar for the same would by announced by Mr Jalan. Neither did that happen nor was the bank rate (6.5%) touched. But the banks were asked to lower the spread over PLR so that credit could be available to borrowers at reasonable rates. While the RBI has been removing supply side bottlenecks, the problem lies with poor demand. Thus, unless some economic recovery happens, credit offtake won't take place. Poor credit off-take has been one of the key drivers of the gilt rally in the last fiscal.

Following the Narasimham Committee II recommendations, RBI has capped commercial banks' daily borrowing and lending in the call market. This is likely to reduce the asset-liability mismatch, which is created when banks build up large positions and fund it through call market borrowing. The idea: banks should tap call markets in dire need and not use this route to finance their routine lendings.

Outlook
Thanks to the CRR cut, Rs 5,000 crore will find its way into the market in mid-June, thus increasing liquidity in the system. In the near term, we expect most segments of the yield curve to show a range-bound movement. Call rates are expected to stabilise at the start of a new reporting fortnight. We will keep you posted. So, watch this space.