BENGALURU : As demonetisation engulfs the economy and tales of woe hit people from near and far, Indian financial markets bore the brunt of both the results of the U.S. Presidential election as well as the crackdown on at least 80 per cent of currency notes in circulation.
However, the debt or bond market is rallying and this rise is being fuelled by rising expectations that the Reserve Bank of India will cut the repo rate further at its monetary policy meeting on December 7.
According to bond dealers and analysts, demonetisation has actually had a positive impact on the bond market.
The reason lies in how bond markets actually work. What drives all financial markets is liquidity and, as a dealer from a private bank treasury tells us, because of demonetisation the banking system has gained ample liquidity now.
“The problem is that when you have sufficient liquidity, your Net Demand and Time Liability (NDTL) will go up, but you have to abide by the 20.75 regulation which is a mandatory requirement.
Now if your NDTL moves higher, you have to buy that amount of bonds which come under the Statutory Liquidity Ratio (SLR) category into your portfolio. So much buying will happen in the Government security market,” said the dealer.
Banks also have to maintain a stipulated portion of their NDTL in the form of liquid assets like cash, gold and unencumbered securities and report their holdings to the Reserve Bank of India every alternate Friday as part of their status report of SLR maintenance.
Once that SLR is bought in from the market, there will again be ample liquidity which has to be deployed somewhere.An analyst from ICICI Securities told Express that for deploying this SLR, the banking sector has two major avenues at its disposal.
The first is the financial market investment route and the other are credit side investment.
“Now, you know that in our country, credit side investments are not picking up, so you can’t deploy your funds beyond a certain point in that sector. The only remaining avenue is the bond portfolio and the non-SLR portfolio,” he pointed out.
When it comes to deploying funds, the issue is that banks are not sure until when these funds will remain with them. “You never know when the withdrawal restrictions will ease and the people will take out money from the banking system. So deploying in the equity market or in any other risky market will be very difficult for the banks,” pointed out the analyst. Investing in bonds however, is the better option, as you can invest and exit more easily as it is more liquid.
This, analysts point out, is the reason behind the rallying bond market and why the benchmark 10-year bond yield dived 36 basis points to 6.44 per cent, a 7 and a half year low, since the announcement on November 8.
“But, not every bond is rallying, it is the most liquid ones, like the benchmark bond and the near-end bonds.
You never know when the money will go out of the system so it is wise to invest in the more liquid bonds so that whenever you require that money you can go out of the market. The interest rates have come down so much that they are below the repo rates,” said A K Prabhakar, Research Head, IDBI Capital Market.
“Despite U.S. yields moving higher, despite currency getting hit, despite oil moving higher, all negative concerns which should have put a cap have been neutralised by the immense liquidity,” he added.