Yields on short-tenor debt fall on surplus liquidity

By Manish M. Suvarna

Yields on short-term debt instruments such as treasury bills and commercial papers fell sharply over the week as liquidity in the banking system remained in surplus even after the central bank conducted variable rate reverse repo (VRRR) auction to absorb excess liquidity.

Since August 10, yields on commercial papers issued by NBFCs and manufacturing companies maturing in three months fell by 10-20 basis points while those on treasury bills eased by 5-6 basis points across maturities. Similarly, the yields on G-Sec such as 5.63%-2026 and 5.15%-2025 and corporate bonds with less than five-year maturities eased by 10-15 basis points.

“Short-term money market rates are closely tracking the prevailing liquidity conditions. Liquidity surplus has increased substantially in the last few weeks due to RBI’s bond and FX purchases. This is putting downward pressure on money market rates,” said Pankaj Pathak, fund manager, fixed income at Quantum Asset Management.

Short-term yields were expected to rise after the first VRRR auction, but instead they eased further because the liquidity still remained in a huge surplus. The surplus liquidity is playing a significant role in dragging rates down on money market instruments and it was further supported by lower issuances in the market.

Meanwhile, demand from mutual funds remained steady because they are witnessing strong inflows into shorter-end funds.

“Inflation and rising Covid cases forced investors to move towards short-end funds, where risk is low compared to longer-end funds,” a fund manager with a mid-sized fund house said.

Fund houses have witnessed the highest inflows in funds maturing in six months, such as liquid and ultra-short duration funds. However, medium to long-term funds have seen a huge outflow, according to the Amfi data.

To remove excess liquidity from the system, VRRR auctions have been announced by the central bank, of which the first auction was held on August 13 and saw strong demand from investors. In that auction, the central bank received bids worth over Rs 4.50 lakh crore, while it accepted only Rs 2.50 lakh crore. The next auction is scheduled for August 27 for a notified amount of Rs 3 lakh crore.

The central bank in its monetary policy has enhanced the amount of VRRR auctions with a view that there is a higher appetite for this in terms of the bid-cover ratio. The RBI also warned that the enhanced VRRR auctions should not be misread as a reversal of the accommodative policy stance.

Dealers said they did not see any uptick in yields after the increase in VRRR amounts by the central bank because outflows have been offset by the inflows on account of RBI bond purchases. In this quarter, the central bank has decided to purchase government securities worth Rs 1.2 lakh crore to support the market.

But liquidity may reduce in September due to expected VRRR, outflows of advance tax and an increase in currency in circulation because of the festive season. This will stop rates from going downward and a marginal rise can be seen. Usually, currency in circulation increases before the start of the festive season.

“We may see some reduction in liquidity surplus from next month onwards due to tax outflows and seasonal pick-up in cash withdrawals, thus this downward trajectory in short-term yields may not continue,” Pathak said.