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Fixed Income

Cash Management Bills go at 11.70%

Today’s 11,000 cr. auction of 35 day cash management bills are seeing yields that haven’t been seen before: 11.71%

35 day cash management bills yield

Now, things should be cool for banks. Borrow from the MSF window at 10.25% and get paid 11.70% by the government.

This can only work until 1% of net demand and time liabilities for all banks, and if everyone does it the demand will max out at about 76,000 cr. (assuming no one wants MSF for any other reason). So this measure will take time to act and squeeze out liquidity.

Assuming banks want about 20,000 cr. in the MSF window right now, we should see stress after about five such auctions (55,000 cr. would have been taken out). That translates to around the end of August, just before the governorship of the RBI transfers over to Raghuram Rajan.

At that time, the banking system will have a tough time finding liquidity, so I expect all sorts of rate increases at the short end, and some will permeate to the long end as well.

For investing it might be prudent to wait till this materializes before buying longer term bond funds. Liquid and ultra-short term funds should only be bought by those that can stay in for about two more months and ride out volatility.

Equities are going to suffer if this happens, as things will get tough even for the best-of-breed borrowers. (Think of it, if the government has to borrow at 11.7%…) So I would wait before I plunged into the equity markets as well.

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