Yields on short-term papers have hardened significantly following the rate hikes by the Reserve Bank of India (RBI) and tighter liquidity conditions in the banking system.
While the yield on commercial papers (CPs) and certificates of deposit (CDs) maturing in three months were trading near 10-year benchmark government bonds yields in the last few days, long-term yields have remained range-bound.
CPs are unsecured, short-term debt instruments issued by corporates to finance short-term liabilities. CDs are issued by the banks to meet their short-term funding requirements.
CPs issued by non-banking financial companies maturing in three months are trading in the 7.25-7.45 percent range and papers issued by manufacturing companies were trading at 7.10-7.35 percent. Similarly, CDs having three months’ maturity were trading at 6.85-7.05 percent.
On the other hand, the 10-year benchmark government bond yield is at 7.42 percent.
“Yield curve has flattened due to a sharp hike in the repo rate since May and tighter liquidity conditions. The liquidity condition is going to tighten further from here on. If the RBI doesn’t provide liquidity support, money market rates will move higher,” said Pankaj Pathak, fund manager, fixed income, at Quantum Asset Management.
High short-term rates
The yields on short-term debt instruments rose sharply soon after the liquidity in the banking system started tightening amid expectations of a higher terminal rate than predicted earlier.
“We have a higher short-term rate on fears of a higher terminal rate going forward and the rate will remain elevated until there is any clear indication by the central bank to pause rate hikes,” said Umesh Kumar Tulsyan, managing director of Sovereign Global Markets, a New Delhi-based fund house.
Dealers expect that the terminal rate will remain in the range of 6.40 percent to 6.50 percent.
The banking system has been facing a liquidity crunch over the last few weeks due to heavy currency outflow on account of festive season credit demand and regular intervention by the RBI in the foreign exchange market to keep the rupee from falling sharply.
Usually, in the second half of the financial year, currency leakage increases sharply as spending goes up on account of the festival season.
Currently, liquidity in the banking system is estimated to be in deficit of around Rs 54,918.53 crore as on October 28, according to a dealer at a large state-owned bank.
The liquidity deficit in the system narrowed on October 28 due to some inflows on account of payment by the government towards salaries and pensions, dealers said. Liquidity was in deficit of around Rs 73,296.89 crore on October 27.
A dealer from a state-owned bank also said that it will improve in the coming days on government salary-related inflows.
Issuances
Most banks have in the last few weeks started issuing CDs to tide over the liquidity crunch.
To meet the rising demand for loans in the festival season, banks also borrowed funds from the central bank. Credit growth is near 18 percent, which is much high than the growth in deposits.
Prime Database data showed that banks raised Rs 44,170 crore between October 1 and 25, and Rs 47,340 crore in September.
However, CP issuances remained lower at Rs 64,005 crore till October 25, compared to Rs 1.39 lakh crore raised in September.
"If there is a capital crunch, then organisations can try to tide over the problem of delay in projects by raising money at higher rates for the short term, hoping to substitute it with long term funds as liquidity improves. We might see some spike in the issue of Commercial Paper in the coming months," said Manoj Trivedi, Co-Founder at Jama Wealth- An SEBI registered investment advisory firm.
The way ahead
Money market dealers expect rates on short-term instruments to continue to rise so far as tight liquidity conditions prevail. However, some dealers expect rates to cool down from here on.
“Now we will soon see the rate on short-term paper start coming down as it has almost touched a peak and it’s almost 140 to 150 basis over the repo rate,” Tulsyan said.
