HSBC Sees India Yield Dropping to 7% as Rajan Gets Cash Flowing

  • Three-month treasury bill yield slides to lowest since 2010
  • Interbank rate averages 6.62% in April, versus 7.19% in March

Reserve Bank of India Governor Raghuram Rajan’s measures to tackle a cash squeeze are starting to bear fruit.

A benchmark overnight interbank rate has averaged 6.62 percent this month, 57 basis points lower than in March, data compiled by Bloomberg show. HSBC Holdings Plc sees money-market costs falling further as the RBI buys bonds in the open market, predicting the 10-year sovereign yield will drop to 7 percent by year-end, a level last seen in 2009.

The RBI is signaling a “significant change in its liquidity management,” said Himanshu Malik, a strategist at HSBC in Hong Kong. “We expect liquidity in the banking system to move into a slightly surplus mode in the next one or two months on the back of increased government spending and permanent liquidity infusion by the central bank.”

Rajan surprised the markets this month as his decision to lower key interest rates for a fifth time since early 2015 was accompanied by a series of steps to boost liquidity and enable lenders to pass on the benefits of monetary easing more widely. Citigroup Inc. estimates the RBI will buy as much as 1.2 trillion rupees ($18.1 billion) of bonds in the year ending March 2017.

“Rajan’s new framework will bring about a paradigm shift in liquidity management,” said Vivek Rajpal, an interest-rate strategist at Nomura Holdings Inc. in Singapore. “There will be more bond purchases as the RBI seeks to pump more money into the banking system. As there will be more funds, money-market rates will come down.”

Lower rates augur well for Prime Minister Narendra Modi’s government as it embarks on its record 6-trillion rupee borrowing program for the year that began April 1. An auction of three-month treasury bills last week saw a cutoff yield of 6.81 percent, the least since November 2010, data compiled by Bloomberg show. The rate was at a four-month high of 7.35 percent in early February.

Rajan cut the daily balance requirement for lenders’ reserve ratio and lowered costs for emergency funds. He pledged to continue to provide liquidity as required, with the aim of bringing the cash deficit at banks closer to neutral from the previous target of 1 percent of their own net demand and time liabilities. The benchmark repurchase rate was reduced by 25 basis points to 6.5 percent.

Bond Purchases

The central bank acted after last quarter’s outflows of foreign money from Indian debt exacerbated a seasonal cash crunch. The RBI has purchased securities worth 864.09 billion rupees since resuming open-market operations in December. Nomura’s Rajpal estimates OMO purchases of close to 1.5 trillion rupees in the year through March 2017.

Sovereign bonds surged in March after the government’s budget restraint and slower inflation led to anticipation of monetary easing. The benchmark 10-year yield slumped 16 basis points in the debt’s best March performance since 1999. It has dropped another three basis points in April to 7.44 percent in Mumbai on Wednesday, and earlier in the month reached its lowest level since June 2013.

“The overnight rate is likely to gradually drop to around 20-30 basis points below the repo rate as liquidity in the banking system improves,” said Malik of HSBC, predicting the 10-year yield to decline to 7 percent by end-December.

Overseas demand for local notes seems to be picking up after the weather department’s forecast of the first above-average monsoon in three years boosted optimism higher crop output will bring down the inflation rate from a six-month low. Foreign holdings of rupee-denominated government and corporate debt rose 17.4 billion rupees last week, the most since the period ended March 25, National Securities and Depository Ltd. data show.

Expectation of normal weather has created a favorable environment for moderation in food prices, which have an important bearing on overall inflation outlook and inflation expectations, Morgan Stanley economists led by Chetan Ahya wrote in an April 18 report. They expect the RBI to lower rates by another 50 basis points in this financial year.

The liquidity measures mark “a very significant change in the monetary policy stance,” said Rajeev Radhakrishnan, head of fixed income at SBI Funds Management Pvt. in Mumbai, which oversees 1.07 trillion rupees of assets. “The transmission is instantaneous in money markets, as reflected in the lower cutoffs at treasury bill auctions. Gradually, we’d see other market instruments such as certificates of deposit also adjusting in line with this.”

Before it's here, it's on the Bloomberg Terminal.