Overnight rates to remain volatile

Bond yield climbs 11 bps due to RBI's liquidity management measures

The Reserve Bank of India (RBI)'s decision to cut the Statutory Liquidity Ratio (SLR) by 50 basis points (bps) hasn't cheered the market much, since overnight rates seem likely to continue to be volatile.

SLR is the minimum bond holding requirement for banks as prescribed by RBI. Overnight rates were volatile in June-July due to slow government spending and RBI mopping dollar flows through forward swaps.

SLR now stands reduced to 22 per cent of banks' Net Demand and Time Liabilities (NDTL), with effect from the fortnight beginning Saturday. The central bank also said it would continue to provide liquidity under overnight repos at 0.25 per cent of bank-wise NDTL and liquidity under seven-day and 14-day term repos of up to 0.75 per cent of NDTL of the banking system.

Besides cutting SLR, the central bank also reduced the total holdings of SLR securities in the held-to-maturity category by 50 bps, to 24 per cent of NDTL from Saturday. These measures dampened the bond market, due to which the yield on the 10-year bond rose sharply by 11 bps, to close at 8.61 per cent. The concern in the market is the cut in the SLR limit might impel banks to sell their illiquid bonds. The yield had previously climbed by 16 bps on April 2 to 8.96 per cent.

"The expectation was that the quantum of term repos would be increased or RBI might hold special term repos to ensure overnight rates remain anchored to the policy rates. We will wait and see if RBI acts more pro-actively; else, the volatility in overnight rates might continue," said R Sivakumar, head of fixed income and products, Axis Mutual Fund.

On Tuesday, the weighted average of call money rates was 7.73 per cent, compared with 7.76 per cent the previous day. On July 24, the weighted average of call rates even breached the nine per cent mark and was quoted at 9.01 per cent. RBI had said on many occasions that it wanted the overnight rates to hug the repo rate, which is at eight per cent.

"Overnight rates have come down because of some government spending. A 50-bps SLR cut releases about Rs 40,000 crore of liquidity, available for banks to do credit lending. But this will be only over a period of time," said Lakshmi Iyer, chief investment officer (debt), Kotak MF.

In the earlier bi-monthly review, too, RBI had reduced the SLR by 50 bps, to 22.5 per cent. However, it had also reduced the liquidity provided under the export credit refinance facility to 32 per cent from the earlier 50 per cent. To compensate, it had introduced a special term repo facility of 0.25 per cent of NDTL.