Inter-bank call money markets were volatile due to a shorter week and withdrawal of 1/3 of the Primary Dealers’ refinance limits from the fortnight starting 5th May. Call money traded in a range of 7.25% to 8.25%, closing the week at 7.42%. The RBI’s reverse repo rate (the flexible rate at which RBI lends short term money to the inter-bank market) was lowered from 9.00% to 8.75%. This was a sequel to last week’s reduction by the RBI of it’s repo rate (the rate at which the inter-bank market lends short term money to RBI) from 7.00% to 6.75%. But not much money was lent or borrowed from RBI throughout the week - i.e. RBI infused liquidity at the end of the week was nil. Even with the call being volatile, the 3 month Overnight Indexed Swaps (OIS) - 3 month fixed rate which can be swapped against daily compounded overnight call rates - remained close to 8.00% levels, indicating that even with the current volatility in call rates, inter-bank participants do not expect the same to remain on an average over a 3 month period.
Government Securities
The government securities markets were range bound on the back of the cuts in the RBI’s repo and reverse repo rate by 25 basis points. There were expectations of a Bank Rate cut when the finance minister, Mr. Yashwant Sinha, announced that interest rates would move in tandem with the global trends and that it was upto the RBI to lower them. The medium term GOI securities remained in the 9.37% s.a. to 9.33% s.a. yield range. The far end of the curve moved more than the short end. 19-Yr GOI was traded at 10.61% (down 10 bp for the week) and 10-Yr GOI was traded at 10.06% (down 5 bp for the week).
* All yields mentioned are annualized and spreads are over annualized GOI Securities
The short term credit markets were steady with the 2 ½ and 3 months commercial papers (CPs) being dealt at 9.15% - 9.25% in the secondary market. ICD markets were dry with not much activity and the 3 month rates remained at 10-25 basis points over corresponding CP rates. However, this week belonged to the medium term corporate bond market, with a rally in the spreads over GOI securities. With the medium term GOI securities remaining stable, the spreads over GOI securities fell to 80 basis points (from 95 basis points, last week) for 5 year AAA corporate issues. With not much supply in the primary markets, the mutual funds and select foreign banks bought prime quality corporate names. The absolute 5 year AAA annualized yield fell from 10.50% to 10.35%.
The government has already issued dated papers worth Rs. 28000 cr. in April (almost a quarter of the entire year’s gross borrowing). This is due to the Rs.10000 cr. shortfall in the government tax receipts last year, and would put pressure on next year’s borrowing targets. May has traditionally been the month where the government borrows most. With the Government’s WMA - temporary RBI overdraft limit on the government - being almost zero, it also would have facility to borrow from the RBI’s WMA limit. Hence, even if there is an auction, it might be limited to Rs. 4000 cr., especially as the week has just balanced liquidity. And with a limited borrowing in the first two weeks of the month, this May could prove to be different. We do not expect RBI to stress the overnight call markets. With the kind of interest rate noises being made by the finance minister and the RBI, we expect a cash reserve ratio (CRR) cut of 50 basis to improve sentiments for the government borrowing, A bank rate cut of 50 basis points may happen in or after June.
In the call markets, apart from the state loans designated outflow of Rs. 3800 cr. on 8th May, there are no outflows yet from the system. There are inflows of Rs. 1700 cr. into the banking system in the form of coupon inflows. The liquidity looks just fairly balanced. Any further Government securities auction, this week, should put further pressure on the overnight call. The overnight call rates should stay in the 7.25% to 8.25% range. With the RBI indicating call rates to be lowered and decent liquidity starting from the last week of May, we recommend receiving fixed rate 3 month OIS at 8.00% - 8.15% levels - i.e. receive a fixed rate of 8.00%-8.15% and pay a daily compounded overnight inter-bank call rates at the end of the 3 month period. The GOI securities markets look range bound in absence of any further interest rate indications and a GOI security auction would depend on the government’s spending last week.
The action would be in the corporate bonds market. There is yet a lot of steam in the secondary markets as long as the GOI securities remain stable and hence we expect the 5 year AAA prime names to trade lower at 10.25%-10.30% range. However, these are historic, all time low rates and would tempt a lot of AAA corporate names to issue their paper in the primary market at these levels. This would put some supply pressure on the markets.
With short term liquidity just balanced, the recommendation is to maintain a stable short term borrowing profile and as the medium term corporate bonds markets are showing strength. Overall, we suggest corporates borrow 40% of their annual requirements in medium and long tenor. Moreover, 50% of this amount may be borrowed currently, while the corporate bonds markets show strength. The remaining 60% of annual requirements should be concentrated in the short tenors (depending upon the cash requirements, corporates could maintain about 50% of their short term borrowings in the short term floating rate form).
Short Term Liability Management Commercial Papers: Corporates having access to CPs, could wait before borrowing the direction of short term rates is stable and call rates can fall to the 7.00-7.25% range. This would push the CP rates down from the current 9.25% levels to 8.90%-9.00% levels.
MIBOR Linked issuances: Mutual funds are receiving a good amount of money for their liquidity funds and hence corporates could issue MIBOR linked papers to them (floating rate borrowings whose rate of interest is a particular basis points over call rates).
Short Term Foreign Currency (FC) Loans: Short term foreign currency (FC) loans on fully hedged basis could be an expensive source to raise short term funds. And borrowing the same on an unhedged basis could prove dangerous as forwards could come under pressure as the Fed is likely to cut rates on 15th May FOMC meeting. Hence, any unhedged borrowings should not be undertaken.
Medium and Long Term Liability Management Rupee Borrowings: This is a perfect time to borrow in the medium and long term markets. With the corporate bond markets showing strength and reduced credit spreads, corporates could borrow in the 3 years and 5 years segment, depending upon their credit rating. Corporates should look to completing at least 50% of their overall long term borrowing before this rally comes to an end in about a month's time.
Foreign Currency (FC) Borrowings: Corporates wanting to raise medium and long term FC loans could borrow in Rupee for the similar tenor and swap it into FC loans. For prime corporates this could be at 50-60 basis points over GOI securities, i.e. for e.g. a corporate borrows at 10.35% for 5 years in the Rupee markets and converts the same into floating rate FC borrowing by conducting a long term FC swap, where, the corporate receives a fixed rate of 10.00% (60 bp over annualized 5 year GOI security) and pays USD LIBOR. This would, in effect, convert their borrowing into LIBOR + 35 bp for 5 years. This has a risk of LIBOR moving up but we trust the Fed to revive the U.S. economy in the short term.
Corporates with surplus short term cash could deploy it in Money Market Mutual Funds (which could give an average return of (7.50 - 8.50%) or even Income Funds (which could average around 10.00%). With Vyaj Badla proposed to be discontinued, corporates could even look to investing in P1+ ICDs (8.50% to 8.75% for 1 month), depending upon their surplus tenor. If surplus funds are more than 3 months, it is recommended to invest in Income Funds or in Financial Institutions’ CDs / short term bonds (which could yield 10.20% to 10.40% for 1 year bonds) or even highly liquid PSU bonds. Avoid direct deployment in GOI securities, as the markets could be very volatile.
Short termCash Management
Indicative Returns
DISCLAIMER
The above views are based on the latest available information. Though the information sources are believed to be reliable, the information is not guaranteed for accuracy. While the views are proffered with the best of intentions, neither the author, nor the firm are liable for any losses that may occur as a result of any action based on the above. The financial markets, and especially the Indian money markets, are illiquid and inherently risky and it is assumed that those who trade these markets are fully aware of the risk of real loss involved.
Unauthorized copying, distribution or sale of this publication is strictly prohibited.
Home
Government Securities
