Short-term debt gets cheaper due to higher surplus systemic liquidity

CP and CD

Borrowing cost for banks and corporates through short-term debt instruments has reduced sharply in last few weeks due to huge surplus liquidity in the banking system. Yield on commercial papers (CP) and certificates of deposit (CD) reduced by 30-45 basis points (bps) in May.

According to the market participants, yield on CP maturing in three months were trading in the range of 6.5-6.55 percent on May 27, as compared to 6.85-6.90 percent in start of May. Similarly, yield on CD was trading in the range of 6.1-6.15 percent as on May 27, as compared to 6.5-6.55 percent as on start of May.

The reduction in the short-term debt rates also implies that 50 bps rate cut by the Reserve Bank of India (RBI) between February and April has been transmitted in full along with liquidity infusion program conducted by the central bank.

Experts are also of view that the rates on these instruments may further come down if the central bank cuts another 25 bps rates in June policy, which is widely expected by the market due to inflation staying below the medium target of 4 percent of RBI and concerns over growth.

Moneycontrol’s poll of economists and fund manager suggest that the central bank may cut the repo rate by 25 bps at the upcoming review on June 6. The MPC of the RBI will convene on June 4 and deliver the outcome on June 6.

CPs and CDs is an unsecured money market instrument issued in the form of a promissory note by corporate borrowers and banks, respectively, to diversify their sources of short-term borrowings and provide an additional instrument to the investors.

Money market experts said huge surplus liquidity in the banking system has helped these yields to fall in the primary as well as secondary market.

Currently, the liquidity in the banking system is estimated to be in surplus of around Rs 1.89 lakh crore as on May 27, according to the Reserve Bank of India’s (RBI) data.

The surplus liquidity has widened to Rs 1.89 lakh crore from Rs 1.29 lakh crore in the start of this month due to maturity of government securities, which added to the surplus.

Along with this, open market operations (OMO) purchases of governments securities conducted by the RBI this month has also added liquidity worth Rs 1.19 lakh crore to the banking system.

In the last few months, OMO purchases has provided substantial liquidity to the banking system leading to system turning into surplus mode. This, along with rate cut by the RBI, has helped bond and money market yields to soften sharply.

The central bank had started a series of OMO in January this year in order to infuse durable liquidity into a banking system that was reeling under a squeeze.