Call rates move up, so do bond yields

The Reserve Bank of India hiking reverse repo rate in its recent April policy has served its intended purpose.

The overnight call rate which, until then, was hovering far below the RBI’s key policy repo rate, at 5.7 per cent levels, has moved up to 6-6.1 per cent levels over the past month. The 3-month T-bill rate too has gone up by 20-30 basis points since April.

RBI had raised the reverse repo rate — the rate at which banks lend short-term funds to RBI — by 25 basis points to 6 per cent, in the April policy, while keeping the repo rate — the rate at which banks borrow short-term funds from RBI —unchanged at 6.25 per cent.

Under a normal circumstance (neutral or deficit liquidity) the impact of the notable rise in short-term money market rates should have led banks to increase deposit rates at least in the very short tenure buckets. But the still ample liquidity has kept a tight leash on deposit rates that have fallen sharply by 75-100 basis points post demonetisation last November.

Then and now

In either situation of tight liquidity or excess liquidity, the RBI’s objective remains the same — to ensure that the key policy rate is the operational rate. The immediate fall-out of excess liquidity over the past few months has been the sharp cuts in deposit rates by banks. The call rate also fell below the repo rate to 5.7 per cent levels.

In a bid to align the call rate close to repo rate, RBI raised the reverse repo rate from 5.75 per cent to 6 per cent. This has led the overnight rate to move closer to the repo rate.

Deposit rates continue to fall

Despite interest rates in certain segments in the market moving up, bank deposit rates continue to fall. Only recently, SBI reduced deposit rates by 25-50 basis points in certain long tenure buckets (upwards of 2 years). Rates on the shorter tenure deposits have remained unchanged.

Yields on 10-year G-Secs too have trended higher over the past month, moving up by nearly 30 basis points. Selling pressure from banks have kept government bond prices depressed and yields higher. In the month of March, both PSU and private banks were net sellers. For April, PSU Banks continue to be net sellers to the tune of Rs 25,000 crore.

A few banks have increased deposit rates selectively. Bank of Baroda, while reducing deposit rates in the 1-2 years bucket by 10 basis points to 6.9 per cent, raised rates in the longer tenure deposits. Axis Bank too, has raised rates in certain buckets for high value deposits.

What for depositors and investors

With the RBI’s rate cut cycle coming to an end and rates starting to inch up in certain quarters, sharp cuts in deposit rates are unlikely from hereon. But given the surplus liquidity in the system, banks are unlikely to hike deposit rates too in a hurry.

Over the past two months, banks continue to lend funds from around ₹80,000 to 1 lakh crore under the variable reverse repo window across various tenures.

Given the upward pressure on bond yields, investors should, stay clear of duration calls (betting on rate movements) and, instead, invest a chunk of their debt fund investments in short-term income funds that carry less volatility in returns.

Liquid funds that invest in money market instruments such as call money, CBLO, and treasury bills, may see some gains in the short term. Liquid funds earn returns through accrual, and the increase in short term rates over the past month are likely to benefit these funds.

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