Tuesday, April 21, 2009

[Investors Please Listen] Post Policy Pulse - G-Sec yields revel in plush liquidity and policy rate cuts

Policy makers dole out further rate relaxation

With India nearing the end of the rate softening cycle, on April 21 RBI Governor Dr. D. Subbarao continued the central bank's dovish stance while announcing the Annual Policy statement for 2009-10. Key rates were slashed 25bps, leaving the reserve ratios unchanged. While the apex bank revised down FY09 and FY10 GDP growth targets, the policy statement expressed concern over absence of proportionate pass-through (sticky policy transmission) by banks and further room for reduction in deposit rates.

Impact analysis

As the RBI tampers with policy rates to help revive the economy from the current slowdown, positive momentum continued in the domestic bond market. Given below is the brief analysis of the impact of the policy on various segments of debt market:

n         Sovereign debt: With 25bps cut the investor enthusiasm is likely to continue. We expect further softening in the benchmark yield that is likely to test sub-6% levels. With plush liquidity in the system and dwindling credit growth, auction cut-offs are expected to be aggressive as banks divert their funds from the measly 3.25% reverse repo window to more lucrative bond markets - expected to witness sustained buying pressure.

n         Corporate debt: The non sovereign debt market movement is subject to their supply. While liquidity is an overriding factor at the short end of the curve, G-sec movements will influence long dated bonds:

1.      CD and CP: We do not expect further softening at the short end of the non-SLR curve from current levels. The one-year state subsidiary CD after rate cut fell by ~50bps to 5.25% levels. However, such low rates are primarily on account of plush liquidity which has resulted in sustained buying from mutual funds. We expect the buying pressure to sustain which is expected to contain the short term rate (one year) to sub 5.50% levels.

2.      Corporate bonds: Since the inflow is primarily towards short term funds, the demand has been primarily in less than five years maturing papers. While five and 10-year maturing papers will exhibit stickiness on dearth of investor enthusiasm, less than five years maturing papers (mainly one–two year segment) will revel in the bidding pressure.

n         Liquidity will continue to be buoyant in the system in the current quarter on account of inflows from OMO buyback, interest payments, redemptions and MSS unwinding. Although as per table 1 there is cumulative outflow of ~INR 500 bn from the system, overall excess funds cash will continue to be above INR 600-750 bn (advance tax payments not included). The overnight money market rates will, therefore, continue to hover close to the reverse repo rate of 3.25%.

n         Swap rate is unlikely to witness any steep correction from current levels. The one year rate, which has already eased to 3.77 levels, will exhibit stickiness at current levels. Five year segment is likely to trail sovereign debt, as we anticipate some softening in G-secs the five year OIS is likely to ease from current levels.

Road ahead and options left with RBI: We strongly anticipate further monetary measures in the form of reduction in policy rates of 50bps over Q1FY10. Since the system will continue to be flooded with surplus funds we anticipate no reduction in reserve ratio from current levels.
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