Impact on Recent RBI Measure On Debt Market.

What impact will the recent RBI measures have on debt markets? (A note issued by Mirae Asset Global Investments says short term funds with the duration of 1.5 to 2 years should perform better than longer term debt funds on risk return scale) In a move to check the currency's volatility, the Reserve Bank of India has decided to ·         Lower rupee liquidity in the system by capping the liquidity adjustment facility at (LAF) Rs 75,000 crore from 17th July, 2013. ·         The marginal standing facility (MSF) rate has been raised 200 bps to 10.25%. ·         RBI has also decided to conduct open-market sales of government securities worth Rs 12,000 crore on July 18 which will further suck rupee liquidity out of the system. These policy measures amount to a de facto tightening of monetary policy. Coming in a period of sub-trend growth, the RBI has made its intentions clear – exchange rate stability precedes growth as a policy objective. 15-Jul-13 16-Jul-13 3 Month CP 8.44 10.43 1 Year CP 8.86 10.39 3 Month CD 8.02 9.70 1 Year CD 8.32 10.28 10 Year G-Sec 7.56 8.10 Source: Bloomberg, 16 July, 2013 There has been a sharp spike in the debt yields today. Most of the instruments have seen spike of 100-200 bps in the short duration. Debt Market Outlook o   The steps taken will not only squeeze INR liquidity from the banking system, but it will also make borrowing cost higher. We expect rates to harden in response and anticipate a bear flattening of the yield curve. o   The overall outlook for the longer term debt is not so positive. The OMO sale of the RBI is indicator that possibility of bond purchases has reduced drastically. In absence of triggers like rate cuts and OMOs the longer term yields will more higher from here. o   The shorter term yields are expected to more along with the systemic liquidity, we expect the yields on 3 to 6 months papers to get realigned at 9 % levels in near future. o   In this view the short term funds with the duration of 1.5 to 2 years should perform better than longer term debt funds on risk return scale. o   Given all these facts we rule out any possibility of rate cuts in first half of the fiscal