The domestic money markets have gone for a toss after the Reserve Bank of India (RBI) announced a 50 basis point and 25 basis point rise in the repo and cash reserve ratio (CRR) respectively, while unveiling the quarterly review of annual monetary policy on Tuesday.
Market participants said the yield on the 10-year benchmark paper, jumped to 9.51% immediately after the RBI announcement. It had touched 9.24%, just about 15 minutes before the announcement of the policy.
There were talks about a technical error in the RBI server, which led to the policy being leaked out to news channels and agencies, which put even more pressure on the bond markets.
On Tuesday, the 10-year benchmark paper ended at 9.40%, up from Monday?s close of 9.07%. Five-year overnight swap rates, which are the most liquid interest-rate derivative contracts, ended at 9.63/9.68%, nearly 40 bps higher than 9.24/9.29% on Monday.
Going forward, dealers anticipate the bond market to remain very bearish, as yields would succumb under pressure.
?The hike in CRR is likely to suck out Rs 9,000 crore from the banking system, which would put pressure on liquidity. While, we expect bond yields to cross 9.50% in another 2-3 days, we think it would inch up further upwards thereafter,? said NS Venkatesh, MD and CEO with IDBI Gilts Ltd.
In a bid to control inflation, the repo rate and the CRR have gone up by 125 bps and 150 bps, in the last three months.
Shailendra Jhingan, head of fund management, fixed income at HSBC Asset Management expects the yield to move up to 9.75% over the coming months and also the yield curve to flatten in the coming months.
?We feel that long-term investors may consider allocating their wealth to bond and gilt funds at these levels,? he added.
As it is, the financial market is currently experiencing a liquidity deficit and the central bank is infusing an average of Rs 40,000 crore of liquidity under the liquidity adjustment facility, on a daily basis.
Dealers say the proposed CRR hike will sustain the current bout of tightness during this quarter. With the reverse repo corridor left unchanged, the LAF corridor has now widened to 300 bps.
?However, considering that the liquidity is expected to remain tight in the foreseeable future, the operating rate for short-term funds will be the repo rate. We expect the call money rate to remain in the vicinity of the repo rate during this quarter,? said GV Nageswara Rao, MD, IDBI Fortis Life Insurance.
With bond yields inching up, banks having a high proportion of AFS portfolio would now have to make higher provisions towards MTM losses. Union Bank of India, Allahabad Bank, Indian Bank would be the most impacted, said Abhishek Agarwal, research analyst, banking and associate vice president of Religare Securities.