BOK meeting preview; RBI to support INR bonds

Group Research - Econs, Ma Tieying / Apr 08, 2020

The BOK may cut rates by 25bps as early as Thursday. Rise in Indian bond yields may require RBI support.

Photo credit: Unsplash Photo

South Korea: BOK rate cut on Thursday

The Bank of Korea is expected to cut rates by an additional 25bps in 2Q, as soon as the policy meeting tomorrow. The COVID-19 situation in South Korea has begun to stabilise and the financial market stress has eased after the BOK’s 50bps emergency rate cut in March. Nonetheless, external environment has deteriorated sharply over the past one month, due to the intensifying COVID-19 and lockdown/shutdown in US, Europe and Southeast Asia. Lower interest rates are needed to mitigate the impact of external income shocks on corporate/household balance sheet.

A further 25bps cut in the benchmark repo rate is expected to push down the 3M CD rate below the 1% mark, to about 0.9%. The GFC-like liquidity support measures adopted by the BOK, such as unlimited repo operations, should also help to compress the short-term rates. Long-term yields may have bottomed, however, given the expansion in fiscal policy and the increase in KTB issuance. The KRW11.7tn supplementary budget passed in March requires additional bond issuance of KRW10.3tn. A second supplementary budget worth KRW7tn is being drafted, according to media reports.

On the FX front, the KRW is consolidating in the 1200-1250 range vs the USD after a heavy sell-off in March. The BOK has entered into a USD60bn currency swap arrangement with the Fed to strengthen reserve positions, and relaxed the macroprudential measures aimed at curbing capital inflows during the post-GFC period (e.g., cap on banks’ FX forward positions, levy on foreign currency borrowings). The stabilisation of the KRW will, in turn, provide the needed leeway for the BOK to further lower domestic rates.

India: Rise in bond yields may require RBI support

India’s bond issuance calendar is set to be heavy over the next few months, even before factoring in any COVID-19 related spending. The central government plans to raise 63% of the FY21 issuance i.e. INR 4.9trn in 1HFY21 (Apr-Sep20). This implies weekly offerings of INR 190-210bn. Add to this is INR 3trn worth T-bills, and state bonds of INR 1.3trn (+15% yoy) in 2Q20. This heavy supply pipeline, in midst of low volumes and spike in volatility (due to lockdown restrictions) have driven 10Y bond yield (generic) up ~30bps this month. Trading hours in FX and bond markets have been shortened to quell volatility. Borrowing costs of states also rose in Tuesday’s auction. After rejecting few bids, they raised INR325bn vs planned INR375bn.

With an eye on the upcoming issuance, the RBI is helping to ease states’ ability to borrow. States’ ways and means advances (WMA) limit was raised by 30% last week. On Tuesday, the number of days that states/ UTs can be in overdraft was extended to 21 days vs 14 days earlier, to tide over short-term funding mismatches. The centre has reportedly given states the leeway to frontload as much as 50% of their annual borrowings, according to the local press.

Taking a leaf of the central bank’s response to a (sharper) squeeze in risk-free yields back in 3Q18, expectations are high for a replay. Back then, a steady stream of bond purchases (INR2.5trn) had helped tame yields. The present juncture of weak global sentiments, portfolio outflows and banks’ worries over the supply pipeline have left yields firm, despite a host of liquidity measures announced in the past few weeks. Participants have pinned their hope on the central bank’s support not only via secondary market purchases, but also in primary auctions (permitted under extraordinary circumstances). Signs of support will help ease 10Y yields back towards 6.2% and below.

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