Transmission is faster in bond markets

While borrowers of loans from banks have been benefiting in fits and starts from the RBI’s rate cut over the past year, the transmission has happened much faster in the bond markets, benefiting certain borrowers.

The yield on one-year commercial paper, for instance, has fallen by about 70-80 basis points so far this year even as banks have been dragging their feet, cutting lending rates by 10-15 basis points. This has aided corporate borrowers who have a good rating and have been able to raise funds from the bond market.

According to data put up by the RBI recently, while credit from the banking system has grown by 19.2 per cent between March 2014 and March 2016, credit from the non-bank system — corporate debt and commercial papers, among others — has gone up by 37.4 per cent during the same period.

Bankers say that many corporate borrowers have been able to make the best of lower rates in the bond markets to raise funds. Yields on top-rated AAA corporate bonds have fallen by about 80 basis points this year to 7.4 per cent, with much of the reduction happening post the April policy, when the RBI last cut its key policy rate. AA rated companies, which rank a notch lower and pay about 30-40 basis points more than top-rated companies to source funds from the secondary market, have also gained from the notable fall in rates.

Yields on these bonds too, have fallen by about 40 basis points this year.

Punjab National Bank, which shows the rate it charges its SME customers based on the risk profile, gives some indication of the wide disparity in banks’ lending rates and bond market yields.

According to PNB’s website, for corporate borrowers rated highest at AAA, it charges a loan rate that is 20 basis points higher than the respective MCLR (marginal cost of funds-based lending rate ). For instance, loan rates on working capital loans, benchmarked against one-year MCLR, add up to 9.5 per cent. This is far higher than the rate at which AAA borrowers are able to borrow from the bond market currently. This, to some extent, highlights the wide difference in rates in different markets though the gap could be wider or narrower.

While the transmission of rates will continue to happen at a smoother pace in the bond market than through banks, a sharp fall from hereon is unlikely despite the RBI’s rate cut on Tuesday.

Short- to medium-term bonds react more nimbly to policy rate actions as they are more sensitive to rate cuts and liquidity infusion. As we near the end of the rate easing cycle, markets are likely to factor in current rates rather than future expectations and this should limit the downside in bond yields.

“We expect one year CP to move up to 7.7 per cent by March next year from the current 7.4 per cent, reflecting stronger refinancing pressure that is typically the case over January-March,” said Suyash Choudhary, Head, Fixed Income, at IDFC Mutual Fund.

The market reaction to the rate cut on Tuesday has been muted as the yield on the 10-year G-Sec remained more or less unchanged at 6.7 per cent levels. But the bond market has already rallied sharply this year in anticipation of rate cuts and because of the RBI’s open market operations (OMOs) — buying of government bonds to provide liquidity — since its April policy.

This helped suck out the excess supply of government bonds, leading to bond prices moving up and yields sliding. From 7.7 per cent levels in the beginning of this year, yield on the 10-year G-Sec has fallen to 6.7 per cent, a notable one percentage point fall. While markets are factoring in another rate cut, a sharp fall in yields as the one seen in recent months, is unlikely.

“For one, OMOs will not be bunched up as before. Also, if the market believes that 6 per cent is the terminal repo rate (and doesn’t expect further easing from thereon), then the appetite for duration after the next 15-20-basis point fall in yield may be limited,” said Choudhary.

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