Incremental CRR may push up short-term rates by 15-20 bps

Usually, tighter liquidity in the banking system pushes short-term rates higher in the market due to lower supply of monies

Rates of short-term debt instruments are likely to increase by 15-20 basis points (bps) in the next few days following the introduction of the Incremental Cash Reserve Ratio (I-CRR) by the Reserve Bank of India (RBI).

On August 10, the central bank said that with effect from the fortnight beginning August 12, scheduled banks will have to maintain an I-CRR of 10 percent on the increase in their net demand and time liabilities (NDTL) between May 19 and July 28.

This will remove a little over Rs 1 lakh crore from the banking system, RBI Governor Shaktikanta Das said at a press conference subsequent to the monetary policy committee meeting on August 10.

Usually, tighter liquidity in the banking system pushes short-term rates higher in the market due to lower supply of monies. Currently, liquidity in the banking system is estimated to be  in a surplus of around Rs 2.64 lakh crore.

“We expect the short-term rates of money market instruments like call money, treasury bills, and commercial papers to increase by 15-20 bps in the near term,” said Anil Gupta Senior Vice President, Co Group Head-Financial Sector Ratings, ICRA.

Further, on the 10-year benchmark bond, Pankaj Pathak, Fund Manager-Fixed Income, Quantum AMC, said that Indian bond yields will remain between 7-7.30 percent over the coming months, tracking crude oil prices and US treasury yields.

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Movement in short-term rates

Ever since the withdrawal of Rs 2,000 banknotes from circulation, yields on short-term debt instruments such as commercial papers (CPs), certificates of deposit (CDs), and treasury bills had eased by 10-15 bps. This is because about Rs 2.18 lakh crore had entered the banking system due to the move, lifting the liquidity.

For instance, yields on CPs issued by non-banking finance companies, which ranged between 7.20 and 7.30 percent on May 18, fell to 7.10-7.30 percent on August 9. Yield on CDs fell to 6.90-7.10 percent on August 9, from 7.00-7.10 percent on May 18. Similarly, yields on the treasury bills fell up to 10 bps across tenures, between May 17 and August 9.

However,  following the introduction of the I-CRR, dealers expect rates to move north in the coming days.

“We expect the short-term money market curve of 3-6 months maturity to be negatively impacted,” said Puneet Pal, Head-Fixed Income, PGIM India Mutual Fund.

Fund raising

In July, companies issued CPs worth Rs 91,764.7 crore compared to Rs 1.50 lakh crore in June, according to NSDL data.

Similarly, CDs worth Rs 44,800 crore were issued in July, against Rs 73,385 crore June.

Money market dealers said that usually short-term debt issuances dip  during the start of the quarter, and pick up in the last month as companies roll-over their papers during that period.

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Why the I-CRR?

The central bank has announced I-CRR with an aim to manage the higher surplus liquidity caused by the  return of Rs 2,000 notes to the banking system.

“This measure is intended to absorb the surplus liquidity generated by various factors, including the return of Rs 2,000 notes to the banking system,” said Das.

In the last few months, liquidity in the banking system has risen sharply after the withdrawal of Rs 2,000 notes, the transfer of RBI’s surplus to the government, uptick in government spending, and capital inflows.

To manage this, the central bank has conducted various variable rate reverse repo (VRRR) auctions of different tenures, but  received muted response from the banks, as they preferred holding on to the liquidity to avoid seeking funds later under the Marginal Standing Facility (MSF). The MSF allows banks to borrow from the RBI in emergencies at a rate higher than the repo.

Since June, the central bank has conducted 16 VRRR auctions for Rs 18 lakh crore. However, banks parked only Rs 7,73,023 crore in these auctions.