First Quarter Review of Monetary Policy 2011-12 - RBI stumps with 50-bps hike; Inflation target hiked to 7%

The RBI revealed its super hawkish monetary policy for the first quarter 2011-12 by raising the policy repo rate under the liquidity adjustment facility (LAF) by 50 bps.  The repo rate will now move to 8 per cent. This is 11^th successive hike since Mar 2010 and the fastest monetary accommodative uncovering in the world. Consequently, the reverse repo rate under the LAF, at a spread of repo rate minus 100 bps gets adjusted to 7 per cent. Similarly, the Marginal Standing Facility (MSF), determined at a spread of 100 bps above the repo rate will move up to 9 per cent.

Repo rate is the rate at which RBI lends to banks and Reverse repo rate is the rate at which RBI borrows from banks. The new term Marginal Standing Facility (MSF) is the additional borrowing window for banks set up at 100 bps above repo rate and they can borrow overnight up to one per cent of their respective Net Demand and Time Liabilities (NDTL).

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Fiscal Deficits at sub-5.5 per cent vs Higher Borrowing – which one to stick with?

Too many cooks spoil the broth! Rightly said... Post the global financial crisis, many countries – developed and emerging economies went for expansionary monetary and fiscal policies to revive their slowing economy. In India too, the slowdown of economy forced the Central Bank, the RBI and Central Government to announce a series of monetary and fiscal policies which shook the Indian Government’s finances. Three major expenses like provision for Sixth Pay Commission, Loan Waiver and MGNREGA (Mahatma Gandhi National Rural Employment Guarantee Program) and various other subsidies including policy rate cuts led to significant intensification of the India’s Fiscal Deficit.

These unplanned expenditures in terms of loose policies and subsidies have badly affected the fiscal deficits. For Fiscal Year 2010-11, the Central Government fiscal deficit and combined gross fiscal deficit have been pegged at 8.2 per cent. However, there is an apprehension that it can shoot up further. In FY 2009-10, the fiscal deficit was 6.8 per cent of GDP. For FY 2011-12, it has been projected to bring it down to 4.4 per cent.

So, what happens if the fiscal deficit shoots up?

It means that the government will borrow extra to finance their planned and unplanned expenditures. If the government borrows extra for its spending, the level of money supplies rises which may compel to print more money, thus, leading to a hike in inflation rate. 

Current Scenario

With the improvement in economic conditions, the RBI has rolled back many of its accommodative measures introduced in year starting from 2008-09 bringing the policy rates to pre-crisis level. The net borrowing of Rs. 3.81 lakh crore will be executed smoothly except at few occasions where it has been devolved to PDs. However, the 3G and WIMAX auctions which collected worth Rs. 75,000 crore created the liquidity fissures which became a daily headache for RBI. In many occasions, the RBI has reiterated its comfort in repo borrowing up to 1 per cent of Net Demand and Time Liabilities (NDTL). However, the borrowing has been in range of over 2 per cent of NDTL which prompted the RBI to cut the SLR to 24 per cent and also introduced bond repurchase worth Rs. 48,000 crore under OMOs in four tranches.

The tight liquidity scenario was contemplating that the government may go for cancellation of some of its regular weekly borrowing as it has some unspent revenues lying with them. However, the Finance Ministry found support after the Nominal GDP data was released which rose on high inflation and on account of new series in headline inflation as measured by WPI. The nominal GDP
which expanded 19.8 per cent in the first half of the fiscal year 2010-11 provides the room for additional borrowing if the growth rate is intact in the 2^nd fiscal and the budgeted borrowing would amount to 5 per cent of the GDP only. The nominal GDP figures have risen due to burgeoning high
inflation rates which have been in double for most part of years and a new inflation index i.e. 2004-05. 

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Since the fiscal numbers are calculated in current prices and if the government sticks to the number plan, it may have an additional room to borrow. The 5.5 per cent budgeted Fiscal Deficit of the GDP was thought of on account of assumption of 12.5 per cent growth in nominal GDP. However, it has grown at 19.8 per cent in the first half of the FY 2010-11; so the government may announce in reduction of Fiscal Deficit number at sub-5.5 per cent or may go for additional borrowing.

Given the tight liquidity scenario, it is unlikely that they will go for additional borrowing.  However, the quantum of OMOs done totaling Rs. 41,266 crore (in four tranches) may give a reason to borrow again beyond the budgeted specified limit if the liquidity improves in the financial system so as to finance its social schemes. After all, the election preparation is on!

Happy Reading!       - Amar Ranu

Nov 02 policy review eyed

Highlights:

• Amid tight systematic liquidity, the RBI announced a special second LAF, a liquidity window for scheduled commercial banks to borrow to the extent of up to 1.0 per cent of their Net Demand and Time Liabilities (NDTL) as on Oct 08 on all days during Oct 29-Nov 04, 2010. The RBI also announced a special 2-day repo auction under the LAF on Oct 30, 2010 which saw a total borrowing of Rs. 11,025 crore under LAF. The RBI also allowed waiver of penal interest, if any for any shortfall in maintenance of SLR on Oct 30-31, 2010 out of these special facilities.

• The buy-back programme as announced by the government did not draw good responses from the market – with bids worth Rs. 3,174 crore tendered against the notified amount of Rs. 12,000 crore. However, the total amount accepted for buy-back was Rs. 2,148 crore only.

• The benchmark bond seemed to lose its appetite after volume shifted to 8.13% G-Sec 2022 as the market expected that 7.80% G-Sec 2020 may not see any auctions further. However, comments from a Finance Ministry official who hinted that the 10-year bond will retain its benchmark status till fiscal year end led to a swift rally in it. Further, the RBI’s special liquidity window led to fall in yields. The 10-year benchmark paper closed at 8.11, down by 3 bps over the week.

• India’s primary articles’ inflation fell to 16.62 per cent in the week ended Oct 16 from 18.05 per cent in the last week while food articles’ inflation fell to a 50-week low of 13.75 per cent from 15.53 per cent a week before.

• Growth in India’s key infrastructure industries, which constitute 26 per cent of IIP figures fell to a 19-month low of 2.5 per cent in Sept compared to 3.9 per cent and 4.3 per cent in Aug and a year ago respectively.

View & Recommendations:

• The special liquidity window announced by RBI may ease the structural liquidity crisis. The RBI is looking to normalize policy rates given high inflation; however, it feared that the QE-II (Quantitative Easing 2 to be announced by Fed Reserve) may bring more capital inflows into the system which will force the RBI to contain the rupee appreciation. This may lead to inflation hike further.

• The market participants have expected a hike of 25 bps in policy rates to be announced by RBI on Nov 02. The market has already factored into the 25 bps hike in policy rates. So, yields might not move significantly if there is hike in policy rates. However, the government may decide to cancel the auction after which the government bonds may witness a rally.


Broader Perspectives:

Bond Front

The buy-back programme announced by RBI did not draw strong interests from market participants. Bids worth Rs. 3,174 crore were tendered against the notified amount of Rs. 12,000 crore. However, the total amount accepted for buy-back was Rs. 2,148 crore. The securities which are bought back are 8.75% G-Sec 2010, 12.32% G-Sec 2011 and 6.57% G-Sec 2011 for notified amount of Rs. 28.97 crore, Rs. 616.35 crore and Rs. 1,502.97 crore respectively. The inflation continued to remain in uncomfortable zone which may allow the central bank to use all its ammunitions, policy rate hikes being the most prominent one. The RBI policy will be announced just before the much awaited US Federal Reserve announcement regarding the much touted QE-II, or second round of quantitative easing. The probability goes high as the US jobless rate hovered around 10 per cent for a third month in October.

The benchmark yield kept on spiraling and touched its near months high of 8.18 per cent. Meanwhile, the borrowing limit in benchmark bond saw a shift in active trading to other yields. The 10-year benchmark paper closed at 8.11 per cent, down by 3 bps. The 8.13% G-Sec 2022 became the most actively traded securities during the last week.

The tight liquidity scenario, an example of structural liquidity deficit led to a hike in interbank call money markets which rose as high as 12 per cent. During the week, the banks borrowed a net amount of Rs. 4.80 lakh crore against the previous week of Rs. 3.17 lakh crore. The Repo and CBLO rate closed at 6.43 per cent and 7.96 per cent, an increase by 72 bps and 261 bps respectively.

The 1/10 year G-Sec spreads fell to 112 bps from 124 bps a week earlier. And the average G-Sec volume reported was Rs. 47,412 crore compared to Rs. 53,776 crore a week earlier.

Bond Supply

The market didn’t have any central government auctions scheduled for this week; however, the SDL (State Development Loans) auctions raised Rs. 8,601.8 crore as against the notified amount of Rs. 8,226.8 crore with the state of Tamil Nadu exercising the green show option to the tune of Rs. 375 crore.

Liquidity

The systematic liquidity remained in deficit mode which allowed RBI to open an additional liquidity window. The liquidity as measured by bids for reverse repo/repo in the LAF (Liquidity Adjustment Facility) auction of the RBI reported a net borrowing of Rs. 4,80,180 crore or daily average of Rs. 80,030 crore.

Corporate Bonds

The corporate bond yields saw a hike in the concluding week. The 10-year AAA bond ended at a yield of around 8.80 per cent compared to 8.76 per cent in the previous week. Credit spreads moved up with 5-year AAA spreads moving up by a basis point to 69 bps levels.

Source: MOSL