CD yields surge, baring liquidity worries

The 25 basis points (bps) cash reserve ratio (CRR) cut by the Reserve Bank of India (RBI) last week, which released Rs18,000 crore, has failed to improve liquidity sentiment.

The nervousness about liquidity was reflected in the yields on bank certificate of deposits (CDs), where one-year yields rose 40 bps on week to close around 9.10%.

The daily market borrowing under the liquidity adjustment facility window of the RBI averaged Rs104,000 crore daily last week against an average of Rs97,000 crore the week before the CRR cut.

February will see the central government borrowing Rs48,000 crore and thestates around Rs20,000 crore. This would put further pressure on liquidity.

The central government is also keeping excess funds with the RBI, leading to liquidity being sucked out of the system.

Deposits of the Centre stood at Rs40,000 crore as of January 25. States, too, are placing excess funds in 14-day treasury bills where the amount outstanding is Rs105,000 crore. Lack of spending by central and state governments coupled with market borrowings will lead to further drain on system liquidity.

The markets are also worried about RBI’s $13.5 billion outstanding forward dollar-rupee contracts (as of November).

The maturity of these forward contracts is a liquidity drain and if part of these contracts matures in the next two months, there will be more pressure.

Topping it all is the sluggish deposit growth and rising credit growth. Between October 2012 and January 2013, credit and deposits grew by Rs233,000 crore and Rs127,000 crore, respectively, leading to banks drawing down on liquidity to fund credit growth. The continuation of this trend in the next two months will lead to sharp shortfall in liquidity.

Advance tax outflows will also hit the system in mid-March and that will also be a big drain on systemic liquidity. Banks that are in need of liquidity will have to pay a higher rate for funds.
CD yields are likely to trend higher in the coming days as banks rush to mop up whatever liquidity is available.

Some banks will be forced to raise deposit rates too in the short maturity bucket to draw bulk deposits.

However, as corporates get lured into higher deposit rates, they will withdraw money from mutual funds, which, in turn, will be forced to sell money market instruments to fund redemptions.

This cycle will push up yields of money market instruments such as CDs and commercial papers.