Short-term yield on corporate bonds higher than long-term yields due to tight liquidity

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Yield on short-term corporate bonds remained higher than those on the long term, usually called as inversion of yield curve in market terms, due to tight liquidity conditions in the banking system. Minimal impact of the repo rate cut carried out by the Reserve Bank of India (RBI) a few weeks ago is said to have led to this situation.

According to the Bloomberg data, yield on AAA-rated corporate bonds have remained inverted since 18-months for 10-year and 3-year, and since 13 months it is inverted between 10-year and 5 years.

Experts also attributed this to the higher demand for the long term papers o corporate bonds by investors such as EPFO, pension funds, and insurance companies.

"In December, strong demand from long-term investors rushing to meet regulatory investment deadlines pushed yields lower on corporate bonds and government securities," said Venkatakrishnan Srinivasan, founder and managing partner of Rockfort Fincap LLP.

In the last few months, demand from the long term investors were on the higher side and that helped corporate bonds as well as government securities yield to move in a narrow range.

Yield on government securities in last few months traded in the range of 6.70-6.90 percent.

Meanwhile, short-term yields stayed elevated due to persistent liquidity deficit in the banking system and uncertainty over RBI’s rate cut stance, Srinivasan added.

The cash shortfall intensified after December 16 because of outflows of over Rs 3 lakh crore due to tax payments. This was despite the RBI reducing cash reserve ratio (CRR) from 4.5 percent to 4 percent in December in anticipation of tight liquidity. While the reduction in CRR helped the system with Rs 1.16 lakh crore, it wasn't enough in the light of RBI’s intervention in the forex market, which cost more than $75 billion, to stabilise the rupee.

The shortfall put pressure on the overnight money market rates, which traded above the RBI’s repo rate. Weighted average call money rates traded in the 6.6 percent to 6.74 percent range since the liquidity turned deficit.

Measures taken by the RBI prevented the overnight rate or call money rate from shooting up but it still remains slightly above the repo rate.

Other money market instruments yields also move in tandem with the overnight rates.

Money market experts said inversion in yield curve is likely to stay till the normalisation of liquidity.