RBI issues fresh measures to bail out banks, mkts to rally

Moneycontrol Bureau

The Reserve Bank of India (RBI) on Tuesday late evening issued another set of steps, aimed at twin purposes; arresting dip in long term bond yields and shielding banks from incurring financial losses due to declining bond prices. Bond yields and prices move in opposite direction. Measure One Instead of squeezing money (monetary tightening) from the system, the central bank announced to conduct an open market operation (OMO) to purchase (not sell) government bonds of Rs 8,000 crore from the market on August 23, 2013. However, RBI will purchase only long-term papers including the government securities (GS) offering 8.15 percent rate of interest and maturing in 2022. Some of the other securities include 7.16 percent GS 2023, 8.33 percent GS 2026 and 8.97 percent GS 2030. "It is also important to ensure that the liquidity tightening does not harden long-term yields sharply and adversely impact credit flow to the productive sectors of the economy. RBI will thereafter calibrate them both in terms of quantum and frequency, as may be warranted by the evolving market conditions," RBI said in press release. Also read: Here's why the bloodbath continued in rupee-bond markets Background Since July 15, 2013; the central bank started taking liquidity measures, which sucked out money flows from the system and aimed to check the rupee’s free fall against the US dollar. A higher demand for rupee is favourable for the exchange rate volatility. However, it resulted in shooting up short-term interest rates and of late, long term interest rates too were impacted. Liquidity effect The latest RBI move is contrary to the earlier measures. The 10-yr benchmark (7.16 percent GS 2023) bond yields had on Monday hit a five-year high at 9.24 percent. However, they recouped losses to close at 8.90 percent. With this "surprise" liquidity injection, bond yields are expected to fall at least 50 basis points (bps) on Wednesday. The move is positive, traders said. Measure Two, The RBI allowed banks to hold Statutory Liquidity Ratio (SLR) bonds in Held to Maturity (HTM) category at 24.5 percent of their respective total deposits or net demand and time liabilities (NDTL). Earlier the RBI had mandated to bring it down to 23 percent from 25 percent "in a progressive manner in a prescribed time frame". Measure Three, Moreover, banks are now allowed to transfer Statutory Liquidity Ratio (SLR) bonds to HTM category from Available for Sale (AFS) or Held for Trading (HFT) categories up to the limit of 24.5 percent as one-time measure. "Such transfer of securities from AFS/HFT category to HTM category should be made at the lower of the book value or market value. Banks have the option of valuing these securities for the purpose of such transfer as at the close of business of July 15, 2013," RBI said. Trigger behind HTM move Since last 1.5 months, bond yields have been falling. It was actually triggered by one Federal Reserve statement wherein Ben Bernanke, the chairman of the US central bank had hinted at withdrawing monetary stimulus and the US bond yields started rising. Overseas investors exited their debt investments in India to park money in US bonds, which are available at attractive prices carrying sovereign US guarantee. Banks hold different bonds generally in three categories: HTM, AFS and HFT. Since July 15, bond yields rose sharply by around 150 basis points following RBI liquidity tightening measures. Estimated MTM loss Therefore, banks are required to book mark-to-market (MTM) losses for both AFS and HFT categories. A shift from these two categories to HTM categories will save lenders from incurring such losses. It is estimated that the entire banking industry may have incurred around Rs 40,000 crore (inclusive of all bonds - GS or corporate papers) loss due to this. Measure Four, In addition, banks can spread over the net depreciation, if any, on account of MTM valuation of securities held under AFS/HFT categories over the remaining period of the current financial year (April 01 – July 14) in equal installments, RBI said. Will the markets rally? Fixed Income Money Market and Derivatives Association of India (FIMMDA), an industry association for money market players was quick to remove the price band on Wednesday (August 21) government bond trading. Generally, it puts a filter of one percent on price/yield movement intraday.  "FIMMDA did it expecting a rally in the bond market tomorrow. Traders are exuberant of today’s RBI measures. Similarly, bank stocks too are likely to rise on the back of RBI measures," an official from the association briefly told moneycontrol.com.  saikat.das@network18online.com