Why RBI’s latest LTRO auction saw weak response

With global central banks upping the ante and announcing emergency measures to tackle the COVID-19 crisis, the RBI too deployed tools to limit the volatility in the rupee and provide cheaper long-term funds to banks through long-term repo operations (LTROs). But the rupee touching the 75-mark against the US dollar and the results of the LTRO auction held on March 18 witnessing poor response, suggest that the RBI will have to deploy other tools in its kitty soon, to tackle the growing fears of COVID-19.

In its February policy, the RBI had announced long-term one-year and three-year repos at repo rate (5.15 per cent) of ₹1-lakh crore. The first auction held on February 17 had seen huge response from banks, with bids to the tune of ₹1.94-lakh crore for the ₹25,000 crore three-year LTRO. The subsequent two LTROs conducted on February 24 and March 2 also saw bids-to-cover-ratio (amount of bids received relative to the amount announced) of about five to seven times.

But the RBI’s recent LTRO auction conducted on March 18 saw a relatively weaker response with a bid-cover of just one time. Against the ₹25,000 crore, bids received totalled just ₹27,000 crore, implying that there were few takers for the cheap funds available at the current repo rate of 5.15 per cent.

What gives?

The intent of the RBI with the LTRO was to ensure long-term one-year and three-year funds to banks at a cheaper rate (than what they generally pay to raise similar funds) which would help banks lower their cost of funds and in turn lending rates. However, the extent and purpose of use of these long-term repos vary across banks.

Some banks may raise such funds to deploy them for lending. But banks with weak credit demand may borrow these funds to earn a tidy spread, by investing the LTRO money in corresponding tenure government or corporate bonds (borrowing at 5.15 per cent and deploying in bonds giving 6 per cent and above yield).

But growing fears of COVID-19’s impact on India over the past week have left banks in a lurch.

Credit growth that is already at a low 3 per cent, is likely to plummet further. Hence, banks have little reason to borrow funds — even at cheaper rates. But why not park the money in safe government securities?

While the spread is attractive, bond markets taking a hard knock over the past few days, is a big dampener.

Rocky bond markets

Despite several global central banks announcing sharp rate cuts and asset buying, bond markets globally are in turbulence. Flight to cash, limited scope for further monetary easing and expectations of huge fiscal stimulus, are keeping bond markets on tenterhooks.

In India too, bond yields have been rising — nearly 40 bps since the low last week. The India 10-year G-Sec is currently at 6.4 per cent. There have been massive foreign outflows from the Indian bond market over the past few days. Overall in the month of March so far, nearly ₹40,000 crore has been pulled out of Indian debt market by foreign portfolio investors (FPIs). Given that the pain in the bond market could accentuate, banks are also wary of parking money in government bonds. The sharp fall in bond prices could lead to large treasury losses in the coming months.

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