With short-term bond yields having come down significantly since the announcement of the long-term repo operations (LTROs) by the Reserve Bank of India (RBI) and the eventual contracting of the spread between the repo rate and short-term yields, the bond market will have very little to gain by participating in any further possible LTROs, say experts. Market participants, however, are of the view that a second tranche is highly likely.
The RBI had first announced its intention to conduct LTROs during the February monetary policy. Since then yields on short-term bonds have come down by 50-60 basis points. For instance, three-year bond yields have fallen over 60 basis points since then. Recently, it hit an over-a-decade low of 5.40%. What is interesting to note is the fact that the spread between the short-term bond yields and the repo has come down so much that the attractiveness of borrowing via LTROs and investing in short-tenor bonds has come down.
Vijay Sharma, senior executive vice-president at PNB Gilts, believes with the economy continuing to remain in a severe slowdown, we do expect that the central bank may consider a second tranche of LTRO. “What remains to be seen is how much will the bond market participate in the news. The short-term yields have come down so much that there is hardly any juice left in such a trade where banks can borrow the LTRO money and invest in short-term securities to profit on the spread. One could see two different possibilities if the second tranche of LTRO happens. Either banks could lose interest in the LTROs in the absence of short-term bond trades or they would actually start using some of the funds borrowed for on-lending which is what the RBI wants. One would have to wait and watch,” Sharma said.
Indeed, the LTROs have had a profound effect on the yield curve— something that interest rate cuts have not been able to deliver in the past. Experts believe that the central bank could look at options like a targeted LTRO where the funds lent to the banks have to be utilised for a set purpose, like onward lending to non-banking finance companies (NBFCs). On Monday, the RBI announced results of the fourth LTRO with a 3-year tenor. The central bank notified that it received bids worth Rs48,856 crore against the notified amount of Rs25,000 crore.
Furthermore, with the US Federal Reserve coming out with an emergency interest rate cut of 50 basis points, market participants believe that a monetary action may also be on the cards.
Ananth Narayan, professor-finance at SPJIMR explains that RBI Governor Shaktikanta Das has always been concerned about growth and financial stability and the MPC as well has continued on its strongly worded accommodative stance since October last year. “The LTRO has been very successful, and has brought down 2 year – 4 year GOI yields by 50-60 bps. Under the current circumstances, the RBI may consider expanding the LTRO program further. Likewise, given lower commodity prices and the possibility of a global demand shock, the MPC may look through current headline inflation, project lower future inflation and consider a policy rate cut of 25-35 bps in the next policy,” Narayan said.