Market participants said the central bank’s hawkish stance and the reduction in the Statutory Liquidity Ratio (SLR) requirement for banks would push Bond yields higher, increasing the government’s borrowing costs.
In the first quarter monetary policy review on Tuesday, the Reserve Bank of India (RBI) had reduced the minimum SLR requirement for banks from 24 per cent to 23 per cent of net demand and time liabilities The new mandate would be effective from August 11.
On Thursday, yields on the 10-year benchmark government bond closed at 8.22 per cent. Dhawal Dalal, executive vice-president and head (fixed income) at DSP BlackRock Investment Managers, said he expected the yields to trade between 8.25 per cent and 8.40 per cent.
Since the policy announcement, yields on the 10-year benchmark government bond have risen 10-12 basis points. “While no rate cuts were priced in, bond yields edged higher by 10 basis points (on the policy announcement), as an SLR cut reduces the captive demand for government securities. If not accompanied by open market operations, the move could keep yields under pressure,” said Rohini Malkani, an economist at Citi India.
RBI Governor D Subbarao said the central bank would conduct open market operations (OMOs) only to manage liquidity, not yields.
Since liquidity is within RBI’s comfort zone of one per cent of net demand and time liabilities, markets do not expect OMOs in the near term.
While growth in bank credit has been in line with RBI’s projection of 17 per cent, it was expected to fall, the central bank said in the macroeconomic and monetary development report released a day ahead of the policy review. This may help keep a check on the rise in bond yields.
“The SLR cut, though negative for the bond market, is not likely to result in banks reducing their holding of government bonds in the near term, given the declining credit growth and the increasing deposit growth. At the same time, the bond market is likely to trade cautiously. We expect a gradual increase in government bond yields,” said Dalal.
However, the impact of the SLR cut would be felt in the second half, when credit growth picks up. N S Venkatesh, head of treasury at IDBI Bank, said, “Banks may resort to cutting on SLR investment from October, when the busy season kicks off. Until then, I don’t see a sell-off in government bonds.”
As of now, the average SLR holding in the banking system is 28-29 per cent. The 100-basis point cut in the SLR requirement has made Rs 60,000 crore of liquidity available to banks.
In its policy review, RBI also raised its inflation projection for the current financial year to seven per cent. In the last three months, inflation has been above seven per cent, and risks of bad monsoons and imported inflation are expected to play out. This leaves lesser room for future rate cuts. “We do not expect rate cuts before the fourth quarter of the current financial year,” said A Prasanna, chief economist at ICICI Securities Primary Dealership.