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The Economic Times

Liquidity squeeze keeps interest rates, bond yields on a high

MUMBAI: The Reserve Bank of India’s interest rate cut is hardly helping investors or corporates as market is moving in the opposite direction due to liquidity shortage with the benchmark government bond yield touching 8%. Some hope for easing of liquidity pressure in the coming fiscal year, but the relief may not be much.

The rates in the money markets, essentially short-term rates, have remained high due to tight liquidity conditions in March and redemption pressure as banks jostled to meet fund requirement. Long-term rates have remained high after RBI made it clear that the headroom for further cuts is limited, unless the consumer prices come off significantly.

“On funding side, year-end pressure has kept the rates high due to the year-end premium embedded in the rates,” said Mohan Shenoi, head (treasury), Kotak Mahindra Bank. “These rates will come down in April. But for government bonds, the yield curve will become steeper because there is not much of a room for policy cuts, at best a 25-basis points cut may be. Knowing this, rates on longer end will remain high and shorter end will come down.” The Reserve Bank of India has cut the key repo rate by a quarter percent to 7.50% on March 19.

Repo is the rate at which banks borrow funds on a daily basis from the central bank. But the cut in key rate has hardly translated into lower interest rates in the government or corporate bond market. Yields on ten-year government bonds touched 8% on March 26, from 7.83% in January. A lot of banks may also be staring at trading losses.

“Banks may have given up on the possible gains they were looking for earlier,” said a dealer from a private bank. “But yields are still 15-basis points lower than what we saw in December,” he added. One basis point is one hundredth of a percentage point.

Call rates, at which banks borrow on an overnight basis from each other, have risen to 9% in the last two days, which was an indication of the stress on liquidity in the system. Banks borrowed on an average Rs 1.25 lakh crore in the last one week. Though it is a typical phenomenon at a fiscal end, the relief in the new fiscal could not be substantial given a structural problem in the system.

Bank deposits are growing at a decade low rate, and the incremental credit-to-deposit ratio is at a near record high of more than 76%. This is a typical phenomenon in March, when rates in money markets tighten as many banks face fund shortage, and need to meet the balance sheet requirements for the year end. “In April, rates on shorter tenor bonds will come down, where we have seen some interest from companies,” said Shashikant Raathi, head, debt capital markets, Axis Bank.
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