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Mumbai: Interest rates at the extreme short end of the curve, such as three-month certificates of deposit (CD) or 91-day Treasury bills, have eased after large banks garnered significant dollar deposits from the diaspora, but a hawkish tone of the panel setting rates has helped harden yields for paper maturing in a year and beyond.

On Friday, the 3-month CD rate for top public sector banks fell to 6.40% from 6.80% a month ago, while the 1-year CD rate rose to 7.30% from 7.09% during the same time frame. Larger banks managed to edge out smaller rivals in garnering more foreign currency non-resident – bank, or FCNR (B), deposits ahead of the advanced deadline of August 31.

“The larger banks, which are the biggest beneficiaries of the FCNR(B) scheme, are absent from the CD market due to excess liquidity,” said V.R.C. Reddy, head of treasury, Karur Vysya Bank. “This low demand from bigger banks has eased up CD rates, which has proven to be beneficial for mid to small banks.”

Banking system liquidity stood at a daily average of ₹3.41 lakh crore in August. In July, the daily average was at ₹1.07 lakh crore.

To be sure, the central bank is due to conduct a record VRRR (variable rate reverse repo) auction of ₹6 lakh crore on Aug 31 to help mop up excess system liquidity.

The Reserve Bank of India (RBI) has preferred the overnight rate to closely align with the repo rate, now at 5.25%. Yet, due to excess liquidity the weighted average call rate (WACR) is trading below the repo rate. In August so far, the WACR stood at 5.12%, down from 5.23% in July.
As of August 21, the RBI’s concessional swap facility had attracted $72.85 billion in total foreign currency inflows, equivalent to nearly ₹7 lakh crore.

Maturities Matter

But the easing in rates is limited to maturities of less than one year, where surplus liquidity has pulled down borrowing costs. Beyond one year, yields have inched higher after the minutes of the August monetary policy committee (MPC) review were published, shortening the odds on an imminent increase in rates – perhaps as early as October.

State-owned REC rejected bids for its ₹3,000 crore 2-year bond issue this week, while PFC pulled its planned ₹2,500 crore 3-year issue after bids came in at higher yields.

Read more: Global Market Today: Asian stocks drop on hawkish Warsh tone, oil gains

The three-year bond would have cost around 7.50%, while PFC was looking to raise funds around 7.25%-7.30%. “The softness seen in very short-term yields has not translated to segments over one year because of the hawkish MPC minutes. Markets are expecting a rate hike sooner rather than later and no one wants to lock in duration in such a scenario,” said Alok Singh, head of treasury, CSB Bank.

RBI governor Sanjay Malhotra during the August MPC review said that he expects liquidity surplus to be temporary and manageable, with excess funds likely to peak around September before being absorbed through normal currency demand, reserve requirements and maturing forex forwards.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of INTU, MO, LRCX either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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