What the Reserve Bank announced on Thursday evening is that it is buying Rs 10,000 crore of 10-year bonds and it is selling back to the market Rs 10,000 crore of under one-year bonds. It is liquidity neutral but the advantage is that there is a lot of appetite at the lower end. Even if the RBI sells under one-year bonds, there are enough people to buy it. You don’t have any problem over there of yields rising because the RBI is selling bonds. But in the 10-year, it has had a very salutary impact because no-body was buying longer-term bonds for fear that the government may expand its fiscal deficit and therefore borrow more – that fear of extra borrowing had kept the yields very high at 6.8 percent.
After this announcement the yields have come crashing down from 6.75 percent yesterday to 6.6 percent in early morning trade today.
Now, what that means is when yields fall bond prices rise, about Rs 2 is the extent of price rise that you are seeing in bonds today and that directly goes to the banks’ bottom line. A lot of banks especially public sector banks have about 8-9 percentage points of their investments in excess statutory liquidity ratio (SLR). You have to keep about 19 percent of your deposits in a government bond. The remaining excess because of risk aversion, you don’t want to lend. Those bonds get cheaper if bond yields rise and that’s what happened on December 5 when the Reserve Bank did not announce a rate cut. The bond yields shoot-up from 6.46 percent to 6.6 percent and thereafter they went all the way up to 6.8-6.9 almost.
Today all the losses up to December 5 have been erased for banks but chances are the yield fall will not stop at 6.6. It may fall further because the expectation in the market is that there can be more such buy-sells announced by the RBI to put pressure on the longer-term yields. With that expectation, you could see bond yields going towards 6.5.
Towards the end of September, bond yields had closed at about 6.6. So as the yields move lower, the banks start making a profit. Chances are that many of the public sector banks which have excess SLRs banks like SBI, PNB, BoI, Union Bank of India, Corporation Bank, UCO Bank, Syndicate Bank – all of them will end with gains by December 31 and that explains the rally in the public sector banking stocks.
Of course, some of the private sector banks are rallying for other reasons. They usually don’t hold for excess SLR also rallying are some of the NBFCs because they can borrow cheap as are automobile stocks – again rate sensitives are getting a positive hue from this development, from this action of the RBI.