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Fixed income markets had to withstand another disappointing week as Reserve Bank of India (RBI) took a series of fresh measures last week to further tighten liquidity in the domestic market by further reducing the borrowing limit under liquidity adjustment facility of banks and primary dealers. In addition, RBI issued cash management bills (CMB) for Rs 6000 crore over and above the scheduled auction of treasury bills.
After comforting statements from administrators last week and in view of the imminent monetary policy review this week, traders were not expecting fresh measures so soon and were once again caught off-guard. After the cancellation of the auction last week, cut-off yields at the weekly auction for 91day T-Bill at 11% and that for 56-day CMB at 11.20%, were easily the highest in the last 15 years, giving some sense of the urgency and decisiveness with which RBI is currently dealing with the volatility in rupee.
The rupee though showed little response yet towards these measures closing the week marginally stronger at 59.04 vs 59.34 last week. If one considers the fact that dollar itself depreciated by more than 1% during the week vs the euro (1.3279 vs 1.3144), the rupee has actually depreciated against all other major currencies. That would possibly suggest that the task is yet unfinished and a sustained vigil would be unavoidable in the short term. Market rates spiked further with short term commercial papers trading at rates as high as 13% as mutual funds and trading banks were seen selling to generating liquidity. Benchmark 10-year government bond yield closed higher by 22 bps at 8.16% after hitting an intra-week low of 8.50% where bargain hunting emerged even though in thin volumes. Corporate bonds continued to suffer massive damage with yields spiking 50 bps for 10-year AAA PSU bonds at 9.20% and 90 bps for 5-year AAA PSU at 9.60%. Intra-week, 5-year AAA PSU hit a high of 10% where strong buying from provident funds and pension funds lent some support.
RBI’s monetary policy review is due this Tuesday. Given the recent measures, the market would be indifferent to any new action like a hike in CRR or repo rate as the market rates have already moved up significantly in the last fortnight. Traders would rather watch carefully for guidance for future months. Any indication on what in RBI’s opinion would amount to some stability coming back to the currency markets would be very important. Our system has now for over two years been greatly dependent on liquidity support from RBI through the liquidity adjustment facility window and that has now been significantly curtailed and the cost of availing that liquidity increased meaningfully. Full impact of new measures will be felt next week as a new reporting fortnight starts. There is no comfort presently that this liquidity window will not be reduced further or the cost not increased further. While higher absolute levels provide temptations, it is important to wait for some tangible signals from RBI on stability coming back in currency markets.
Mahendra Jajoo is Executive Director & CIO-Fixed Income at Pramerica Asset Managers
