What is interesting about the fixed income market is that there have not been any major changes as such in the markets in the past one or two months. This means that there is quite a bit of stability in the rates and the market levels, and this position may not change drastically for another two months or so. This is due to two or three factors which are at work at this juncture.
The first factor is that there is plenty of liquidity in the system and it is expected to continue to be somewhere close to ₹5 Lakh Crs. It is this liquidity that is giving space for fixed income markets to remain stable all the while.
In the last policy announcement, the RBI has initiated additional targeted repo to the tune of Rs.1 Lakh Crs. As stated by the RBI in the policy, “The focus of liquidity measures by the RBI will now include revival of activity in specific sectors that have both backward and forward linkages, and multiplier effects on growth.” To chieve this RBI decided to conduct on tap TLTRO with tenors of up to three years for a total amount of up to ₹1,00,000 crore at a floating rate linked to the policy repo rate. The scheme is available up to March 31, 2021. Liquidity availed by banks under the scheme has to be deployed in corporate bonds, commercial papers, and non-convertible debentures issued by entities in specific sectors over and above the outstanding level of their investments in such instruments as on September 30, 2020.
Another very important measure adopted by the RBI is with respect to SDLs. With the intention of imparting liquidity to SDLs and to facilitate efficient pricing, RBI has decided to conduct open market operations (OMOs) in SDLs as a special case during the current financial year. This action is expected to “improve secondary market activity and rationalize spreads of SDLs over central government securities of comparable maturities.” This would also help further auctions in state government securities much easier when the targets are quite high.
More room for Held to Maturity (HTM) has been provided by the RBI to encourage banks and to hold these papers in the portfolio without worrying too much about where the market is going or where the yields are headed. In the month of Sept. 2019, the RBI had increased the investments permitted to be classified as Held to Maturity (HTM) from 19.5% to 22% of NDTL in respect of SLR securities acquired on or after September 1, 2020 up to March 31, 2021. To provide certainty to banks as regard their investments and for orderly market conditions, the enhanced HTM limit of 22% has been extended up to March 31, 2022 for securities acquired between September 1, 2020 and March 31, 2021. This will help banks to acquire and hold securities, and also plan the investment portfolio in a manner which is comfortable for the bank. These three measures will go a long way in reducing the volatility at the long end of the curve and also in providing greater stability in expectations.
CPI, which indicates retail inflation has been above the 6% mark in the last three months mainly occasioned by high food prices. This uptick in inflation is seen as a “transient hump”, by the RBI, and that inflation may moderate as we move into the last quarter. At the same time when inflationary pressures are high, we may not be able to expect any cut in the base rate. But the rate cuts may not be the essence of the accommodative policy anymore, but liquidity provisioning.
In our view, it is not the rate cuts that matter from hereon, but the liquidity provision that the RBI makes from time to time to support the economy. This assumes great importance due to the fact that there is a huge government borrowing program that is yet to be completed. While such a market borrowing program is on, it has two clear consequences, one, it removes resources or liquidity from the markets to the government coffers, and two, when resources or liquidity is taken away by the government and the RBI the private sector will be denied the resources that it requires for growth. RBI has recognized this issue and has initiated a long-term repo facility to specifically address this issue.
The assurance on accommodative policy and the continuing liquidity support will help the bond markets to remain stable and yields to stay near where they are with very little variations. But the preferred segment of the curve is still the short end and mid-sector of the curve. Investments in this area would be more lucrative on a risk-adjusted basis. The broad range for the current ten year would be 5.80% – 6.20%.
