Short-term govt bond rates harden after incremental CRR guidelines

The yield on the one-year and two-year government bonds has edged up 8 basis points and 4 basis points respectively since August 10

Surplus liquidity in the banking system has fallen significantly with the hardening of short-term rates after the incremental cash reserve ratio (CRR) norms came into effect from August 12.

During the monetary policy review announcement on August 10, the Reserve Bank of India (RBI) mandated all scheduled banks to maintain an incremental cash reserve ratio (I-CRR) of 10 per cent on the increase in their net demand and time liabilities (NDTL) between May 19, 2023 and July 28, 2023, with effect from 12 August.

Following the move, surplus liquidity has dried up to Rs 53,800 crore as of August 20, against Rs 2.6 trillion on August 10.

Yields on the one-year, and two-year government bonds have inched up 8 basis points (bps) and 4 bps, respectively, since August 10. Yield on the 10-year government bond rose 7 bps since the monetary policy and ended at 7.22 per cent on Monday.

The weighted average overnight call rates have largely remained above the policy repo rate — which is 6.5 per cent — after August 11.

In the most recent treasury bills auction held on August 17, the cut off yields on the 91-day and 182-day T-bills were set 13 bps higher than the previous week, whereas, yield on the 364-day T-bills saw an increase of 11 bps.

A section of the market participants expect the Reserve Bank of India (RBI) to extend the period of I-CRR.

RBI governor Shaktikanta Das said the I-CRR norms were temporary and will be reviewed on or before September 8, 2023.

“The market has already started factoring in that one extension will be there at least up to October. It has decided the date on the premise that from September, there will be currency leakage as the festive season starts. But the market thinks that leakage will be starting around October. So, that’s why we are expecting it to be extended for another one month,” a dealer at a state-owned bank said.

Inflation surged in July, coupled with a sharp rise in US Treasury bond yields, indicating that the tight monetary policy may continue for an extended period, dealers said.

“The quantum (yield), which has gone up, is huge and it is not temporary. Market expectation is that it is going to be extended because of this high inflation and the things that are going on in the US and other parts of the world. I think all the market participants are expecting the September deadline to get extended. Whatever the shortfall, on account of advance tax, will be managed through short-term repo measures and not by the revocation of I-CRR,” a dealer at a primary dealership said.

“And, that’s why there is no such demand for the short-term bond. Whatever demand is coming, is in 10 to 15 years, on the higher side,” he added.

There are a few, who are optimistic that the RBI may not extend the I-CRR norms.

“The recent increase in short-term yields can be attributed to several factors, including a higher consumer price index (CPI) number and elevated US yields. Despite a significant rise of around 25 per cent in the overnight interest swap (OIS) market, the bond market, represented by government bonds, has not responded in kind,” said another dealer at a state-owned bank.