Certificates of deposit issuances fall marginally in October, yield rises

According to the Prime database, banks raised Rs 44,670 crore in October against Rs 47,340 crore in the previous month. October fund-raising by banks was the second lowest in the current financial year. The first was in April when banks just raised Rs 17,575 crore.

"Banks have finally started increasing the Fixed Deposit rates across tenors and also giving special rates for deposits over Rs 2 crore.  It may be noted that most of the banks have increased their deposit rates several times in the last few months," said Venkatakrishnan Srinivasan, founder and managing partner at debt advisory firm Rockfort Fincap.

Fixed Deposit rates are comparatively cheaper than CD rates and hence most banks have sought to increase FD rates which were below 6 percent earlier in proportion to CD rates, dealers said.

Uptick in rates 

Rates on short-term debt instruments, including CDs, have moved up sharply after the central bank increased the repo rate and tightened liquidity conditions.

Yields on CDs maturing in three months increased by 65-70 basis points (BPS) in October. The yields, which were hovering around 6.25-6.50 percent, at the start of October, have risen to 6.90-7.10 percent in the last week of October.

One basis point is one-hundredth of a percentage point.

Accordingly, rates on treasury bills also moved up by 210-240 bps across maturities since February 2022.

"The RBI has delivered 190 bps repo rate hike this year and correspondingly, money markets rates have realigned with moving benchmark rates. With inflation above the RBI threshold, rates are expected to remain elevated. The RBI is likely to keep shifting the yield curve higher gradually so as to avoid any liquidity shocks to the economy," said Ajay Manglunia, managing director at JM Financial.

RBI’s rate hike course 

The central bank has so far raised policy rates by 190 basis points since May, but India’s retail inflation continued to remain above its target of 2-6% for three consecutive quarters.

Presently, rates on short-term papers such as commercial papers and CDs are almost at the 10-year government bonds levels. The spread on 1-year CD and 10-year bond, which was close to 225 bps, has now narrowed to 25 bps with tightness in system liquidity and repo rate hikes.

"Short-term yields will eventually be higher than the long-term instruments, as the investors are expected to lock in their rates with long -term instruments.  There is also a short supply of long-term bond issuances as few corporates have cancelled their long-term borrowing due to high cost," Srinivasan said.

Globally, inversion in yields is being witnessed as central banks are focusing on draining excessive liquidity and higher rates to control inflation, which could be a possible scenario if domestic inflation surpasses RBI projections. An inverted yield means long-term interest rates are less than short-term lending rates.

Fixed deposit rates 

Most banks have been aggressively accumulating deposits by offering higher and attractive interest rates to depositors to meet their credit demand.

The mismatch between credit growth and deposit growth has forced most banks to offer high rates on deposits and increase promotional activities for the same.

The primary reason for the rush for deposits is the tightening liquidity in the banking system due to heavy currency leakage and heightened spending on account of the festive season.

The RBI’s dollar sales in the foreign exchange market to prevent the rupee’s depreciation have also tightened liquidity.

After the rate hike by the Reserve Bank of India (RBI) most banks have increased their deposit rates. On average, banks have raised interest rates in the range of 25-80 bps across tenors. Fixed deposit rates of top banks in the three-year to five-year tenor for amounts below Rs 1 crore currently stand between 5.65 percent and 6.75 percent.

Tight liquidity 

The liquidity in the banking system tightened sharply during October and was attributed to several factors including high currency demand on account of the festival season.

Besides, RBI’s forex market operations, along with GST and other tax- related outflows, also drained liquidity, dealers said.

Banks partially compensated the stress by drawing down their excess CRR balances and non-SLR investments. Some banks also took recourse to Marginal Standing Facility (MSF). MSF is a provision made by the central bank through which scheduled commercial banks can obtain liquidity overnight.

At the start of October, liquidity in the banking system was in the surplus of over Rs 1 lakh crore, but by the end of the month, it turned into deficit of more than Rs 60,000 crore.

Money market dealers expect that banking system liquidity to remain under stress for the rest of the financial year.

Last week, RBI governor Shaktikanta Das said the episode of liquidity strain was likely to be transitory on account of several factors.

"First, the leakage due to currency demand will slow down after the festival season; and as currency returns to the banking system, the system liquidity will improve. Second, government expenditure is likely to pick up after the monsoon season. Third, the pace of forex outflows has moderated, which augurs well for system liquidity, going ahead," Das added.

He said deposit growth of banks picked up in recent fortnight and was working towards bridging the funding gap associated with double-digit credit offtake. Banks have adequate cushion of SLR to meet any potential liquidity requirement.

Way ahead 

Money market dealers expect issuances of CDs to rise in the coming months as the demand for funds has increased sharply. "With rising credit demand, CD issuances will continue to rise from banks as retail deposit mobilisation takes time to replenish," Manglunia added.

While the rates on these instruments may also rise, as the shorter end of the yield curve reacts more with change in systemic liquidity.

In the past two years, the system was flush with abundant liquidity which kept the shorter end of the yield curve at significantly lower levels closer to the repo rate and this has turned now.

"The bond yield curve is inverted and we can expect short-term rates to go above 10-year benchmark bond with the expectation of few more rate hikes in the forthcoming MPC policies," Srinivasan said.