Short-term rates to spike further in 2022 as RBI steps up liquidity normalisation

In December, the RBI increased the amount of VRRR auctions and said that from January, liquidity absorption will be undertaken mainly through the auction route.

According to fund managers and brokerage firms, rates on short-term debt instruments are expected to rise by 70-120 basis points over the year. After the December monetary policy, short-term yields have already risen by 25-30 basis points.
According to fund managers and brokerage firms, rates on short-term debt instruments are expected to rise by 70-120 basis points over the year. After the December monetary policy, short-term yields have already risen by 25-30 basis points.

By Manish M Suvarna

Yields on short-term debt across instruments are expected to further rise sharply in calendar year 2022 as the Reserve Bank of India (RBI) has stepped up measures to tighten liquidity from the banking system through regular 14-day and short tenor variable rate reverse repo (VRRR) auctions. Aiding this sentiment are expectations of a reverse repo rate hike in the coming months.

According to fund managers and brokerage firms, rates on short-term debt instruments are expected to rise by 70-120 basis points over the year. After the December monetary policy, short-term yields have already risen by 25-30 basis points.

“RBI has reduced the overall liquidity in the system via long-term reverse repos, which has led to a spike in overnight rates. As a consequence, short-term rates of T-Bills, CPs have also risen steadily. It can be expected that with inflation remaining high, the effective overnight rates will rise between 100 and 150 bps in the next year,” said Sandeep Bagla, chief executive officer, Trust Mutual Fund.

Money market dealers expect liquidity normalisation by the RBI to continue next year too, which will ultimately push short-term rates higher. “Short-term rates reflect that despite the accommodative stance, RBI has begun the normalisation process. We anticipate the same to carry on next year, especially if other central banks too begin to hike rates,” said Sandeep Yadav, senior vice president, head – fixed income, DSP Investment Managers.

Since the August monetary policy, the RBI has been increasing the amount to be withdrawn via 14-day VRRR, which has put pressure on short-term rates. In the December policy, too, it increased the amount of VRRR. This has resulted in a sharp rise in overnight and short-term rates, currently hovering around the repo rate ie, at 4%. With this, the repo rate has again become an operational rate. For the last several months, the reverse repo rate was the operational rate as the central bank had kept abundant liquidity in the banking system.

In December, the RBI increased the amount of VRRR auctions and said that from January, liquidity absorption will be undertaken mainly through the auction route.

Dealers also expect the central bank to hike the reverse repo rate in the next policy. During the pandemic, the RBI kept abundant liquidity in the system, which widened the spread between short-term and long-term papers. But now, short-term rates are seen rising faster than long-term rates, which is helping the yield curve to flatten.

“The yield curve is steep and is factoring in rate hikes by RBI. But some surprises can come from the management of the huge surplus liquidity, which can have a bearing on short-term rates,” said Puneet Pal, head – fixed income, PGIM Mutual Fund.

However, a repo rate hike is not seen coming soon, but in the third or fourth quarter of 2022-23. This is because there is still uncertainty among investors due to the Omicron variant of Covid-19. “We believe that the RBI will keep the repo rate unchanged till September 2022,” said George Heber Joseph, CEO/ CIO, ITI Mutual Fund.

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