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INDIA: Liquidity Feeds the Short End - Update. 

INDIA
IndiaEM BulletBulletAPACEmerging Market News
  • Market consensus today is that the RBI is on hold held true.
  • Whilst the economic data remains stronger than their ASEAN peers, there is no doubt that it is moderating.
  • In addition, the recent bout of USD strength post Trump’s election has caused the RBI to defend the Rupee with US$50bn of FX reserves.
  • The outcome is a stable currency, but liquidity has drained from the system with estimates that core banking liquidity has declined by three quarters (according to research from ICICI Securities – as per BBG).
  • A possible outcome today from the RBI is to maintain the status quo for the Central Bank rate, but reduce the Cash Reserve Ratio (CRR) from 4.50% to 4.25%.
  • The CRR is the proportion of deposits the banks deposit with the central bank.
  • A CRR reduction would represent a meaningful release of liquidity, some of which is likely to end up in the bond market.
  • With IGB curve has flat as it is and not trending anywhere it has been difficult to point to a catalyst for change.
  • We suggested that a  CRR reduction to feed liquidity has the potential to a steepening of the curve as banks re-direct that capital into the short end of the government bond market.
  • The RBI indeed did cut the CRR to 4.0% and longer dated bonds have sold off.
  • We would not expect a cut to the CRR to impact markets immediately as the mechanism takes time for banks to withdraw the cash from the RBI.
  • Over the coming weeks we see room now for the short end to be an area where that cash is invested and bond yields lower. 
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  • Market consensus today is that the RBI is on hold held true.
  • Whilst the economic data remains stronger than their ASEAN peers, there is no doubt that it is moderating.
  • In addition, the recent bout of USD strength post Trump’s election has caused the RBI to defend the Rupee with US$50bn of FX reserves.
  • The outcome is a stable currency, but liquidity has drained from the system with estimates that core banking liquidity has declined by three quarters (according to research from ICICI Securities – as per BBG).
  • A possible outcome today from the RBI is to maintain the status quo for the Central Bank rate, but reduce the Cash Reserve Ratio (CRR) from 4.50% to 4.25%.
  • The CRR is the proportion of deposits the banks deposit with the central bank.
  • A CRR reduction would represent a meaningful release of liquidity, some of which is likely to end up in the bond market.
  • With IGB curve has flat as it is and not trending anywhere it has been difficult to point to a catalyst for change.
  • We suggested that a  CRR reduction to feed liquidity has the potential to a steepening of the curve as banks re-direct that capital into the short end of the government bond market.
  • The RBI indeed did cut the CRR to 4.0% and longer dated bonds have sold off.
  • We would not expect a cut to the CRR to impact markets immediately as the mechanism takes time for banks to withdraw the cash from the RBI.
  • Over the coming weeks we see room now for the short end to be an area where that cash is invested and bond yields lower.