Short-term bond yields moved upwards in the past one month, ignoring persistently high liquidity and tracking their long-term peers, as traders expect US treasury yields to harden in coming months and interest rates to firm in India.
Typically, yields on shorter-tenure bonds tend to be influenced by the liquidity position in the banking system. When the liquidity is in surplus, yields fall, and when the liquidity is in deficit, they harden. Long-term yields, on the other hand, are impacted by the outlook for key interest rates in the domestic market and macroeconomic developments globally.
Since the beginning of April, the yield on the one-month treasury bills have gained 57 basis points to go up to around 6.14%. The three-month treasury bill yield has been trading at about 6.23%, an increase of 45 basis points. The yield on the six-month treasury bill has gained 56 basis points during the period to around 6.35%. The rise in the short end of the curve mirrors gains in the long end. The 10-year benchmark bond yield touched an eight-month high of 6.99% earlier this week. It has gained 26 basis points since the start of the current fiscal.
“The yields have been rising in anticipation of the US yields going up. The market is not taking into account the surplus liquidity. The view is the RBI will gradually soak up the surplus,” the chief manager of treasury operations at a state-run bank said.
Traders expect the benchmark yield to rise to 7.10-15% if treasury yields in the US rise. The US Federal Reserve kept its rate unchanged on Wednesday, but is largely expected to raise rates twice this year. In March, it had raised its benchmark rate by a quarter percentage point.
Excess liquidity in the banking system is around `3.8 lakh crore, driven by a surge in deposits after the note ban. Weak credit offtake due to subdued economic activity has led to pile-up of deposits with the banks.
Growth in non-food credit fell to 6.38% year-on-year during the fortnight ended April 14. The credit-deposit (CD) ratio of the banking system, or the proportion of deposits deployed as loans, fell 89 basis points from the fortnight ended March 31 to 72.05%. This is the steepest fall in the CD ratio since the 330-basis points fall drop between the fortnights ended November 11 and November 25.
Total currency in circulation, which is a major component of reserve money or base money printed by the Reserve Bank of India, has seen a slow uptick since January after falling drastically post demonetisation. The latest RBI data shows that currency in circulation was `1.4 lakh crore as of April 28. In the first week of November, before demonetisation, currency in circulation was `1.8 lakh crore.
“The pace of increase is slower than expected. It might be a conscious decision by the government to drive people to use digital money, or it could be because of delay in supply of the currency paper. Or it could be that people are not converting their deposits because of the interest they are earning on it,” said Madan Sabnavis, chief economist at CARE Ratings.