By Dharamraj Dhutia
MUMBAI (Reuters) – Reserve Bank of India’s plan to infuse liquidity into the banking system daily via variable rate repo (VRR) auctions will lead to a drop in overnight interbank and money market rates, as well as near-end overnight index swaps, traders said on Thursday.
However, yields on the longer duration government bonds are unlikely to fall much as the need for durable liquidity remains unfulfilled, investors said.
WHY IT’S IMPORTANT
Banking system liquidity has tightened over the last month while core liquidity, which includes the government’s cash balances, has moved into deficit, leading to a sharp rise in overnight borrowing costs.
Elevated overnight rates put upward pressure on borrowing costs through short-term instruments like commercial papers, certificates of deposits and treasury bills.
CONTEXT
On Wednesday, the RBI announced it will conduct daily overnight variable rate repo auctions on all working days, starting from Thursday.
Banking system liquidity has stayed in deficit since mid-December, with an average daily shortfall at around 1.65 trillion rupees ($19.08 billion).
MARKET REACTION
The three-month treasury bill yield eased five basis points to 6.55%, while the three-year to five-year bond yields were down by six to seven bps at around 6.70% levels. The 10-year benchmark bond yield eased only by three bps to 6.78%.
GRAPHIC
KEY QUOTES
“The decision to switch to daily VRR is positive for money markets and removes any doubts about RBI’s commitment to keep overnight rate at repo rate,” said A Prasanna, head of research at ICICI Securities Primary Dealership.
This will bring short-term rates closer to the repo rate, but temporary liquidity injection would not have any significant impact on the longer-term yield curve, said Alok Singh, group head of treasury, at CSB Bank.
($1 = 86.4710 Indian rupees)
(Reporting by Dharamraj Dhutia; Editing by Eileen Soreng)
