While the MPC decision of status quo was not so much of a disappointment, the MPC minutes that followed spooked bond markets quite meaningfully. From the policy date (6th Aug) to date, we saw bond yields rise 30-50 bps across segments, especially the mid to longer end. This weakness was leading to some despair in some segments of investors, who were almost convinced that the bond rally was behind us.
Sensing this sentiment and the resultant weak demand for government bonds, the RBI has announced the following measures:
– Special Open Market Operations worth INR 40,000 cr (INR 10,000 cr done in August) and commitment to do more if the situation warrants. Under this arrangement, the RBI will do a simultaneous buy and sell of govt (bonds buy long bonds in this case and sell short-dated bonds )
Impact – Will help flatten the yield curve and also bring down overall bond yields as this will be perceived as anchoring of rates by RBI.
– HTM (Held to Maturity) limit increase – Banks can increase their holding in SLR securities from the presently mandated 18% to 19.5% of NDTL (Net demand and time liabilities) provided the extant limit of 25% of total investment in the HTM category if exceeded is invested in SLR securities with an overall limit of 19.5% of NDTL. Thereby w.e.f. 1st September 2020, banks are now allowed to hold fresh SLR securities under HTM up to 31st March 2021.
Impact – HTM limit increases from 19.5% to 22% (an increase of 2.50%) This would likely create additional demand of INR 3 lakh crore a good source of support for bond yields.
– Special Term Repo Operations at variable repo rates – Banks may opt to reverse their existing LTRO transactions before maturity to lower the cost from 5.15% and avail funds at the existing 4% repo rate.
Impact – Helps banks reprice (Reduce) the cost of borrowing while retaining asset yields as they were to be held to maturity. The very short end of the yield curve also gets supported.
Adding to the above, the Q1 IFY 21 GDP data came in at 23.9% – the worst contraction on record. Bottom line, markets should cheer these measures and we could see a gap down opening in yields by around 15 bps.
We reiterate our view to stay invested despite volatile movement on rates, the broader trajectory to be on the softening side.
Lakshmi Iyer is Chief Investment Officer (Debt) & Head Products at Kotak Mahindra Asset Management Company. Views expressed are the author’s personal.