The financial landscape is witnessing some notable changes, particularly in G-sec yields and liquidity conditions. Let’s explore these dynamics in detail.
G-Sec Yields and RBI’s Rate Decisions
G-sec yields are anticipated to ease further, as the Reserve Bank of India (RBI) is expected to maintain the current interest rates in its upcoming June review. This decision comes amidst a backdrop of high credit growth within the banking system, with banks increasingly relying on Certificates of Deposit (CDs) and raising deposit rates in anticipation of rate cuts later this year.
Liquidity Issues in the Financial Sector
The banking sector is currently grappling with liquidity mismatches. Despite high credit growth, banks are turning to CDs and hiking deposit rates to manage funding. In stark contrast, the government enjoys a more comfortable liquidity position, likely due to slower spending amid the Model Code of Conduct and the Parliamentary elections.
Between April 20 and May 21, 2024, the systemic liquidity deficit averaged ₹1.3 trillion, compared to a surplus earlier in April. The Union government’s cash balances significantly increased from ₹1.1 trillion on April 5 to ₹1.5 trillion by April 19, 2024. This surplus was further bolstered by substantial GST collections and subdued spending, pushing cash balances to ₹2.4 trillion by May 3, 2024.
Government Cash Balances and Treasury Actions
The government’s robust cash position has led to a reduction in planned Treasury bill issuances for Q1 FY2025 by ₹600 billion and the announcement of three buybacks of Government of India securities (G-secs) worth ₹1.6 trillion. However, the total accepted amount in the May 2024 auctions was limited to ₹178.5 billion, only 11.2% of the notified amount.
These buybacks were expected to lower G-sec yields, and along with reduced T-bill issuances, were aimed at easing systemic liquidity. Despite these efforts, liquidity remains tight.
RBI’s Dividend Transfer and Impact on G-Sec Yields
The government’s cash balances likely increased further through May 2024, bolstered by the RBI’s unexpectedly large dividend transfer of ₹2.1 trillion, surpassing the budgeted ₹1.5 trillion. This windfall provides additional fiscal leeway for the government, potentially allowing for enhanced expenditures or sharper fiscal consolidation than initially planned.
A smaller fiscal deficit target could mean lower G-sec issuances in H2 FY2025, supporting lower yields. The typical quarter-end tax inflows, coupled with sluggish government spending until the full budget in July 2024, suggest that systemic liquidity conditions will remain tight. Consequently, the RBI is expected to continue conducting Variable Rate Repos (VRR) to manage liquidity.
Market Expectations and Future Yield Trends
Following the RBI’s dividend transfer announcement, the yield on the new 10-year G-sec dipped to 7.0% on May 22, 2024. ICRA forecasts the 10-year G-sec yield to further ease below 7.0% as Indian Government Bonds are included in the JP Morgan Government Bond Index-Emerging Markets. For the remainder of H1 FY2025, ICRA expects the 10-year G-sec yield to trade between 6.80% and 7.15%. However, yields may approach the upper limit if rate cut expectations by the US Federal Reserve and the RBI’s Monetary Policy Committee (MPC) are delayed beyond Q3 FY2025.
In the upcoming MPC review in June, a status quo on rates and stance is expected. Market participants will closely watch for indications on how the RBI plans to address the systemic liquidity situation in the coming months.
Understanding these trends is crucial for navigating the current financial environment and making informed investment decisions.