Call rates, bond yields ease on expectations of improved liquidity

Yield on 10-year government bond closes below 7%

Money-market rates and bond yields eased on expectations that the Reserve Bank of India’s (RBI’s) decision to pull out the Rs 2,000 note from circulation would improve liquidity. In addition, the RBI’s decision to transfer Rs 87,416 crore as surplus to the central government for 2022-23 also weighed on market sentiment.

Market dealers said the call rates showed a tendency to decline throughout the day. The weighted average call rate was 6.37 per cent on Friday and trended down to close at 6.2 per cent, according to Clearing Corporation of India data.

Soumyajit Niyogi, director, core analytical group, India Ratings & Research, said the liquidity in the system would improve on the back of these two events, and interest rates on commercial paper and certificates of deposits were expected to soften in the months ahead.

The yield on the 10-year benchmark (7.26 per cent maturing in 2033) ended at 6.98 per cent on Monday, after closing at 7.01 per cent on Friday. The three- to five-year bond yields ended lower by about 7 basis points.

QuantEco, an independent economic research house, said actions by the RBI — the purge of Rs 2,000 denomination currency and the transfer of Rs 87,416 crore as surplus to the central government — would benefit money-market liquidity.

While the dividend transfer would have a deterministic impact (Rs 874 billion), the currency withdrawal would have a potential impact ranging between Rs 40,000 crore and Rs 1 trillion.

Even though India’s banking system's liquidity had remained at a surplus of about Rs 60,000 crore in May, overnight rates remained elevated for the most part of the month as the bulk of the surplus was with a few large banks.

The liquidity injection may revive a rally in rupee government bonds, which lost momentum last week after the central bank’s dividend payout to the government fell short of traders’ expectations. A bigger payment would have enabled the finance ministry to cut its bond sales and lower borrowing costs.

The improvement in liquidity could push the shorter-duration bond yields downward, but long-end yields may rise over the medium term with much-anticipated open market bond purchases as well as a domestic policy easing getting delayed, traders said.

Earlier in the day, RBI Governor Shaktikanta Das said the impact of the extraction of Rs 2,000 currency notes would be “very, very marginal” on the economy because it accounts for only 10.8 per cent of the currency in circulation.

The withdrawal exercise is part of currency management operations, and most of the withdrawn Rs 2,000 notes are expected to be returned to the exchequer by the deadline of September 30, he added.