“RBI Report”

n               RBI on March 4, after market hours, gifted the market the much awaited rate cut. It slashed the policy rates by 50bps to 5% for repo and 3.5% for reverse repo. Though the cut was in line with expectations of bond players, select participants (including the corporates) were disappointed as they had anticipated 75-100bps cut in policy rates.

n               Since CY09, banks on daily basis, have parked INR 519 bn in the reverse repo, while bank credit has contracted by INR 122 bn till February 13 indicating a distinct risk aversion. Although the cut is targeted to induce bank lending, we expect no major shift from the current trend as lenders will shy away from sanctioning big ticket credit as ailing sectors are whipped with rating downgrades.

n               Though the sovereign debt market today opened upbeat, yields could not sustain a downside as the benchmark pared all gains; currently trading 20bps above intra-day low of 6.22%. This move was broadly anticipated even as the apex bank now indicates reluctance for any further rate action in FY09.

n               Another culprit for the sell-off is the worry of high supplies. Reeling under supply worries, any improvement (downside) in bond yields observed by the participants is cashed in to book profit, pushing yields north.

n               Till the next policy we anticipate choppy trading in the sovereign debt market with an upside bias for yields. As the most awaited positive news failed to cheer the market and set any positive vibes, we expect volumes to dip and be concentrated only in the benchmark (8.24% GoI 2018) paper. The benchmark is likely to test its previous high of 6.70% in the near term.

n               As the rally in sovereign debt segment ebbed minutes after the market opened, sentiment in non-SLR trades followed suit. Softening of yields on corporate papers was witnessed in the early hours of trade across the curve in both quasi-sovereign and private debt. Participants flocked the market both to pick high yielding debt papers and book profits at lucrative levels. Trades thereafter pared all gains, reverting to yesterday’s levels, REC’s 5-year paper being a case in point, which after improving 25bps closed currently trades at 8.50%.

n               We expect banks who were awaiting reduction in policy rates to be issuing short term debt (rolling over previous year’s issuance) over next 15-20 days, 6-months maturity likely to be the most preferred option. The issuance will impose an upside pressure on yields of short dated securities. At the long-end of the yield curve the five-year paper will continue to remain in the sweet spot relative to the 10-year counterpart that would trail the benchmark sovereign yield.

As shown in table 1 we expect liquidity to be significantly strained from current levels despite RBI’s OMO buyback (table below indicates cumulative outflow of INR 850 bn by March 31), primarily on account of advance tax outflow (assumed at INR 400 bn). Given the current cash surplus of INR 600-650 bn, we would expect a net shortfall of INR 100-150 bn. Considering RBI’s assurance of ample liquidity we expect a heavier OMO purchase and a probable CRR cut before the end of FY09.