CD rates to rise further on liquidity squeeze

Short-term borrowing rates in India are expected to rise further in the next few weeks as companies pay advance taxes, exacerbating a severe cash shortage in the financial system.

Rates on 3-month certificates of deposit were at 9.70 per cent on May 28, higher than any of the first quarters in at least the previous three years, while borrowing rates for three-month commercial paper surged to 10.23 per cent. Bankers expect 3-month CDs to go as high as 10.25 per cent in June and the one-year CD as much as 10.30 per cent.

Unlike years past, cash conditions have not improved significantly in April and May, as government spending that usually kicks in at the start of a new financial year has failed to have the usual impact given the structural deficit in liquidity in India's inter-bank system, analysts said.

Traders are now bracing for worse liquidity conditions as companies are expected to pay as much as Rs 30,000 crore ($5.41 billion)in advance taxes starting in mid-June.

That's especially the case given the Reserve Bank of India has been intervening frequently in currency markets, though it has offset some of the impact on rupee liquidity by purchasing bonds via open market operations.

"Inter-bank liquidity is seen tightening more in June because of further forex interventions, keeping an upward pressure on short-term CD rates," said N.S. Venkatesh, treasurer at IDBI Bank.

The severe cash shortage in the banking system is clearly shown by banks' repo borrowings, which has averaged about 1 trillion rupees a day in the current quarter, well above the Rs 65,000 crore levels the central bank considers normal.

The RBI's bond purchases via OMOs as well as in secondary markets has also not been big enough to offset this liquidity deficit. The RBI has bought Rs 32,087 crore via OMOs over the previous three weeks, and traders are waiting to see whether it will announce a fourth consecutive action this week.

Apart from fresh borrowing, banks are already refinancing existing CDs that mature towards the end of the quarter. Dealers estimate that up to Rs 1,40,000 crore of CDs will be rolled over by the end of June, mostly at the short-end, all of which is expected to further worsen liquidity.

"Redemption and rollover pressure of CDs up to June, especially in three-month segment, will add to the pressure on short term rates," IDBIs Venkatesh said.