Short-term rates trading below 10% for the first time in two years

Drop in interest rates and finance ministry norms on CD issuances contributed to this

 

For the first time in the last two years short-term rates which primarily includes rates of Certificate of Deposits (CDs) and Commercial Papers (CPs) are trading below the 10 per cent mark in the month of March despite a tight liquidity scenario. In 2011, as well as in 2012, in March, these rates had touched double digit.

Two key factors contributing to this are: First, interest rates have dropped and, second, CD issuances have come down due to finance ministry norms. Because of the falling CD rates, CP rates have also come down, as buyers of these short-term papers do not allow the spread between CDs and CPs to widen drastically.

CDs are promissory note issued by banks and are short-term instruments of fund raising. While CPs are unsecured, short-term debt instrument issued by corporates are usually for financing working capital requirements.

The Street is of the view that the CD/CP rates have peaked, and in the near-term they are expected to fall. For example, the three-month CD is quoting at 8.91 per cent currently, and it hovered above 9.50 per cent at the start of the month. Similarly, the three-month CP, which is currently quoting at 9.58 per cent, stood at 9.90 per cent on March 6.

“At this time of last year, the repo rate was at 8.50 per cent, but now, it is at 7.50 per cent. When the market conditions show that the repo rate is falling, obviously that will result in a fall in other rates too,” said Maneesh Dangi, co-chief investment officer, Birla SunLife Mutual Fund.

The Reserve Bank of India (RBI) has cut the repo rate by 100 basis points this financial year in three tranches. The last cut was by 25 basis points earlier this week. The other factor that caused the rates to fall was that banks started reducing their borrowings by way of CDs after the finance ministry issued norms requiring the lenders to reduce the proportion of bulk deposits and CDs to 15 per cent of the total deposits by March 31.

“There is a lack of supply in CDs due to the 15 per cent cap. The credit growth has also been muted this financial year,” said Suyash Choudhary, head-fixed income, IDFC Mutual Fund.

According to Choudhary, CP rates also came down simultaneously because the ultimate buyers are the fund managers who are buying the ultra-short-term and liquid funds that they manage, and they would, obviously, not let the spread between CDs and CPs widen much.

The Street also expects the rates will fall further from current levels, as liquidity deficit, which at present is above Rs 100,000 lakh crore, will ease at the start of the next financial year due to government spending flowing back into the system. “Rates are headed towards lower levels, and the most impact will be on the three-month tenure. CD rates may fall by 100 basis points and CP rates will fall in the range of 75-100 basis points in the next one month,” said Choudhary.