The RBI has just announced another two long term repo operations (LTRO) for three year tenors worth Rs 25000 crore each to be conducted on March 2 and March 9. The response to the first two LTRO’s have been overwhelming with the first one on Feb 17, being oversubscribed almost eight times and the second one on Feb 24 for one year being oversubscribed almost five times. This, despite the fact that there was already surplus liquidity in the system. So why are the banks rushing to subscribe to these bonds at 5.15%? One of the reasons could be that it presented a straight forward trading opportunity. Banks could borrow the money at 5.15% and invest it in G- Secs which were at least 60 -80 bps away from this rate.

In fact, Eurozone banks which partook of the ECB LTRO’s in 2012 did exactly that to help shore up their balance sheets. In 2012, Spanish and Italian sovereign ten-year bonds were available at 4.9%. Eurozone banks, which borrowed from LTRO at 1% could buy these bonds at 4.9% percent, for an instant profit spread of 3.9%. In many instances, the profits helped to shore up the reserve cushions of these banks which were in a dire state. However unlike what Draghi hoped, it did not prompt the banks to lend more since the economic activity in the Eurozone remained weak and the challenges for banks to find credit worthy borrowers remained. What it did achieve was it helped the shaky Eurozone banking system to stabilize as liquidity flooded into the market and banks had enough money to lend to each other and meet their interbank obligations successfully.

In India, the primary aim of the LTRO’s, as per the RBI, was to support transmission of the 135 bps rate cut which had been undertaken by the RBI previously. The immediate impact of the announcement was that overseas investors have rushed into buying sovereign bonds anticipating that both interest rates and forward premiums would fall quickly with the changed RBI policy. FII’s invested close to $904million in the debt markets this month despite the current risk averse sentiment and worries about India’s own growth. If we add in equity flows, the flows climbed to $3000 million this month. No wonder then that while the Yuan has slipped below 7.0 this week, the Rupee is holding near 71.80 levels, seemingly unmoved by the Corona Virus and the supply chain linkages with China. Annualized forward premiums which were at 4.15% before the announcement have slipped to 3.18% currently.

The RBI, like the ECB, will probably achieve one part of its objectives, which is to bring down the cost of money and build easy liquidity conditions in the system. Across the spectrum, G Sec yields have fallen sharply, with the benchmark 10 year bond falling almost 13 bps after the announcement. It is currently quoting at 6.33 per cent. There have been a slew of corporate bond issues from better rated companies keen to cash in at these lower rates. However, it is unlikely that banks will pass on these lower costs to anybody but the best of bank borrowers, who already have access to cheap money directly from the market. Transmission of lower rates is unlikely to see any major tick up as a direct result of this move but the FII money is going to keep coming. Despite the lower interest rates, Indian debt still represents a stable and high yielding carry trade for global investors and now the banks.

I would go as far as to say that if the Corona Virus situation were to stabilize in the following weeks, some of the FII flows, especially what has come into equities, could return back to the South East Asian economies which could recover from the recent downturn pretty quickly. However the flows into debt are likely to be more stable as the growth outlook in developed economies falters and rate cuts and further stimulus in these economies become imminent. Fed Futures is already pricing in a rate cut/ cuts in as early as April at 78% probability. Those holding a near term Rupee depreciation view cannot afford to be complacent.