As inflation rises & liquidity tightens, bond, T-Bill yields rise sharply

As inflation rises & liquidity tightens, bond, T-Bill yields rise sharply

Subject: Economy

Section: External Sector

In News: RBI status quo stance, incremental CRR (ICRR), inflationary pressure and weakening Rupee push yields on 10-year benchmark bonds and Treasury Bills sharply.

Key Points:

• Bond yields have been increasing driven by three major factors: Liquidity squeeze because of ICRR, inflation and weakening Rupee.
• The 10-year is ruling at 7.25 per cent and it does look like that there can be some further upward movement expected as liquidity tightens in the market.The rise in yields is not restricted to India alone.
• Liquidity:
  • Reduction of liquidity in the system is getting reflected in the market as elevated bond yields. As liquidity is tightened and pressure gets mounted on short-term interest rates.
  • The primary reason is the invocation of the incremental CRR (ICRR). The temporary measure will suck out over Rs 1 lakh crore of excess liquidity from the banking system. Surplus liquidity has dried up to just Rs 21,000 crore as of August 14.
  • RBI had, last week, directed banks to maintain an incremental cash reserve ratio (I-CRR) of 10 per cent for banks in order to manage surplus liquidity in the banking system.
• Inflation:
  • Secondly with retail inflation spiking to 7.44 per cent in July, the expectation is for interest rates to stay elevated for the near future.
  • July retail inflation spiked to 7.44 per cent from 4.87 per cent in the previous month as vegetable and cereals prices skyrocketed.
• Weakening of Rupee:
  • The rupee has fallen below the 83 level against the dollar with the dollar strengthening and foreign investors in a nervous mood. This is causing fund outflow seen in FPI selling.
  • The trade deficit caused by falling exports has also adding to the sentiment.
  • To steady the Rupee, RBI is likely to avoid any easing on interest rate front.