Magic of RBI – 2,054 job aspirants per seat

Who says the charm of PSU has died? The volatile and uncertain global scenario had forced many MBA and Engineering aspirants to settle for PSUs in 2008-09 crises but the optimism in following years forced many aspirants to go back to private honchos. In India, the best goes with the best. Be it IITs or IIMs, the best candidate gets the best as per his/her caliber. There is a very tough competition for IITs and IIMs as many students appear for the examination; however, only few candidates are able to make it. In 2011, the number of IIT aspirants was 485,000 for total seats of 9,618; thus, an average of 50 students vie a single seat in IIT. In 2010, the competition was little less i.e. 43. For IIMs, the situation is little better with an average of 69 students vying for a single seat in IIM in 2011. The total number of applicants was 206,000 for a total seat of 3,001 (approximate).

If you believe the next number, you may be in a complete surprise. In the month of Sep 2011, the Reserve Bank of India Services Board, Mumbai invited applications for Officers in Grade ‘B’ for a total seat of 75 including all reservations. To everyone surprise, the total number of accepted applicants are 154,023; thus, an average of 2,054 students will strive for each seat of offered seats on Dec 18, 2011 to appear for its first level. This, as per my knowledge is the highest average so far. The centre from which the maximum students are appearing for this prestigious exam is New Delhi (27,983) followed by Mumbai (13,613), Chennai (13,271), Hyderabad (11,623) and the list follows. Port Blair is having the least number of candidates (62).

Even in the recent past, SBI created a stir when it received a total of 20 lakh applications (approximately) for a total seat of 20,000; thus, an average of 100 students per seat. Also, for prestigious exam like UPSC, an average of 415 (approximate) students vied for a UPSC seat which had a total seat of 965 in 2011.

As per RBI advertisement, the position is a crème de la crème for any job aspirant as the successful candidates may get the opportunity to work in their Economic Policy/Monetary Policy division or other cream divisions. The total CTC as per the job advertisement claims to be Rs. 10 lakh per annum, not bad given the job security will always remain. Even in other PSUs like NTPC, the salary offered is competitive and it matches with the best paying corporate in the industry.

Corporate honchos may recruit the best candidates on day 0 or 1 in all top institutes; some government organizations like RBIs, NTPC still hold the charm in comparison to others and always remain the preferred employer for all candidates.

Fortunately, I have also been appearing for this prestigious exam and competing with other 154,022 candidates for 38 general seats; thus, competing among 4,053 candidates per seat.

Happy Reading!

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).

Click  here to read more....

RBI’s Policymaking – Is the transmission happening?

Post Lehman Crisis, the world scenario changed drastically forcing many nations to follow the accommodative measures so as to ease the liquidity deficit in the financial system. India, too, remained coupled to global events and remained unscathed from a global slowdown because of its increased integration with the global economy.

In India, the Central Bank, Reserve Bank of India took a series of accommodative measures to support the economy. Soon, the world scenario changed with confidence winning and improved numbers. However, the ease of liquidity put pressure on pricing which led to burgeoning of inflation. In real practice, India’s economy gets driven by two factors – first, domestic consumption story which, in recent years, improved on account of increased purchasing power due to various government sponsored initiatives and other factors and second, direct government aids to different sectors/industries in the form of duty cuts or other aids. The multiple factors also put pressure on inflation which also got imported, thanks to high commodity prices including crude oil, to a certain extent due to our large dependency on them.

Also, read – FIIs’ rave party in India; Economic indicators are at loggerheads

In series of steps, the RBI hiked policy rates ten times successively, effectively by a total of 425 points since Mar 2010 in order to tame inflation which had been due to structural reasons too. Every time, RBI raises policy rates, it remains firm in taming the inflation which has become a toy of political storm too.

To support the fast transmission of policymaking, the central bank also made some changes in policy decisions – (1) introduction of base rate (2) the new Marginal Standing Facility (MSF) to support additional lending (3) restrictions on cross-lending between banks and mutual funds which have been rampant till some time ago. However, the RBI expressed its annoyance over the quality of data on which they have been operating the monetary policy. No doubt, the transmission of monetary policy has improved and to a large extent, the hiking of rates have slowed down the demand and also affected the economy growth, thanks to increased interest rates which have raised the average cost of capital. It has affected the capex investment too. In recent times, the RBI questioned the quality of data on Index of Industrial Production (IIP) which measures the industrial growth and Wholesale Price Index (WPI) which is also called as Headline Inflation; these data do not reflect the real economic activity. Volatility still persists in IIP and WPI. Even the recent improvements in IIP and WPI as per 2004-05 series have not helped the central bank; the data get revised by a wider spread on subsequent months. As evident, even the 10 rate hikes, one after another in the past 15 months have not dampened the demand effectively. In the last 2 years, economic forecasts from all government institutions, from Central Statistical Organisation (CSO) to RBI to Planning Commission have been questioned as they turned inaccurate. The high fiscal deficit and continuous gilt supply also kept RBI at bay in effective transmission of monetary policy.

Also, read – Price Hikes – Are we really ready?

Does it say RBI has failed?

Not really! In the past, RBI had been instrumental in taking the country out of the century worst financial crisis; so, it won’t be good to comment on their effectiveness. Their hands are also tied in terms of data availability, political interference (though it is said that RBI is not under the government interference but not in real sense) and dynamic nature of the situation. The various structural issues including supply-related factors also waned the effectiveness of policy transmission. The persistently high food inflation in the last two years has migrated to manufacturing inflation too.

The RBI says that they are handicapped by the reliability of some of the basic data that they need to use in policy calculations which remains true to a large extent. In a nut-shell, India’s inflation must drop before it eats the economy; hope the government must be listening to improve the effectiveness of policy making which are indirectly linked to them.

Happy Reading!

-          Amar Ranu

Financial Stability Report 2010 – A well documented story on Indian Economy

The Central Bank, Reserve Bank of India released its 2^nd Financial Stability Report (Firstone released in March 2010) and thus, it enters into the selected league of countries which publish Financial Stability Review/Report on a periodic basis. In the wake of the global economic crisis, it has become prudent for the Central Banks across the global to assess their financial stability and conduct many stress tests so as to test the nerves of the economies.

Broadly, the report covers that the financial sector remains stress free; however, the intermittent capital flows poses a big challenge as these kinds of flows are very volatile and may get reversed at time of extreme volatilities in origin countries. However, these portfolio inflows have helped financing the burgeoning current account deficit.

It also cautioned that the global economic recovery remain uncertain especially the European region needs to be watched out. Prolonged low interest rates in developed countries encourages higher systematic leverage and also creates a yield seeking environment wherein investors get into crowded traded.

The report also pointed out some soft domestic points where an eye needs to put up. While the domestic growth remains buoyant, the high domestic inflation is a cause of concern due to structural issues. The downside risks still remain and the stressed liquidity conditions warrant caution too. The bubble up in housing sector, especially in some particular regions like Mumbai, Noida, Bangalore and
other cities have prompted tightening of prudential norms which included increasing the provisioning ratio and raising the LTV ratio for higher loans. Read more…

2010 would be remembered a year in Financial Regulation with the passing of Dodd-Frank Act in United States to regulate banks and other financial institutions. We hope that the Central Bank will come with regulations in untouched domains and will take them under their umbrella.

Also read other countries Financial Stability Report/Review which are given below:

Austria – Dec 2010

Canada – Dec 2010 & June 2010

China – Sept 2010

Chile – Sept 2010

ECB – Dec 2010

Germany - 2010

Global by IMF – July 2010

Greece – July 2010

India – Dec 2010 & March 2010

Ireland – 2007

Italy – Dec 2010

Mauritius – Dec 2010

New Zealand – May 2010

Portugal – Nov 2010

Singapore – Nov 2010

South Africa – Sept 2010 & March 2010

Taiwan – May 2010

UK – Dec 2010

Happy Reading!
- Amar Ranu

Yields to fall – Focus on Income Funds

Inflation has started coming down. WPI, the official figure for measure of Inflation came down to 9.97 per cent, 0.03 per cent shy of two digits. The RBI concern on ballooned inflation, a shift of focus from growth to inflation led to a series of monetary policy measures this year, already four times witnessed. More worrisome is the fact that the inflation is no longer food prices driven; in fact it has become more generalized. Non-food inflation has risen from almost zero level in Nov 2009 to 10.9 per cent in June 2010, contribution 70 per cent to inflation.
The bond yields rose abruptly in India, however, the bond yields came down globally. For the first time in its history, the 10-year Indian and US bond yields are facing a divergent state.

The G-Sec markets witnessed hardening of yields in July and Aug 2010. The 10-year G-Sec Bond and Short Term Bonds’ yields have spiked in the recent past; which we believe that they may go up further projected the advance tax outflows in Mid September. The short term yields (1-year CD and CP) have already spiked by 200 bps in the last 3 months. The benchmark bond 7.80 per cent 2020 has already touched 8.08 per cent, currently hovering at 8.03%. It touched its four months high since May 2010. The RBI is still not comfortable with the inflation figures and the market opines that it may go with further rate hikes in the upcoming Monetary Policy meet due in mid-Sept.
We believe that the G-Sec yields in long term will follow its logical course of softening. The reasons are:
• Softening of inflation in coming months
• Improvement in Government revenues in the form of improved tax inflows, 3G and WIMAX auctions
• Reduction in fiscal deficit, if the excess revenue is used efficiently
• Spread in the Repo rate and 10-year G-Sec rate (already at multiple year high) should reduce
• Liquidity is bound to improve; temporarily we might witness liquidity deficiency in the system
• For the first time since 2002, interest rates in India are divergent to US yields (Check the above table)

Since US government continues to follow an expansionary monetary policy to revive growth, the Fed has kept its interest rates abysmal low for another extended period. However, in India, RBI has shifted its focus from good GDP/IIP growth to inflation management; therefore, we witnessed tightening of monetary policy. When inflation comes under control over next few months, bond yields (long dated bonds) will follow its logical course of softening. For those seeking to ride the yield curve at the longer end which could potentially ease in the 2nd half, we would recommend allocations to Income Fund having high average maturity. In the above stated scenario, the income funds stand to benefit with a time horizon of 12 to 18 months.

Yields softened on robust 3G collections and global cues

Highlights:


• Bond yields rallied for the fifth week straight; 10-year benchmark bond 7.80% 2020 settled at 7.37%

• Euro zone crisis continues to led to flight to safety; funds flowing in to US

• 3G auctions fetched Rs. 67,719 crore to government exchequer, much higher than the government expectation of Rs. 35,000 crore; Broadband wireless auction to fetch another Rs. 15,000 crore too

• Comment from a Senior Finance Ministry official that approval of hike in ceiling on FII’s investment in Sovereign Bonds cheered the bond market during the week

• Liquidity remained comfortable; stood at a daily average level of Rs. 42,779 Cr against Rs. 28,749 Cr reported last week

• The 1-10 year YTM spreads decreased by 21 bps to 254 bps

• Government resorted to 28-day Cash Management Bills again over and above its scheduled weekly auction showing that government’s finances are still under pressure

View & Recommendation:

• G-Sec markets are likely to take cues from policy maker statements and will closely watch the Euro Zone for any developments.

• Markets at shorter end of the curve are expected to take cues from liquidity in the system as 3G outflows might put pressure on short term rates.

• The front end of Corporate Bond curve (1 – 5 years) seems to more attractive compared to overnight rates.
Broader Perspectives:

Bond Front

Indian bond markets rallied for the fifth week straight mirroring the US Treasury yields and also on account of positive cues from the domestic market. Higher than expected 3G auctions collection to the tune of Rs. 67,719 Cr along with comments from RBI Governor and Planning Commission Deputy Chairman that the government may cut down its borrowing in FY 2010-11 aided the rally in bond prices. Moreover, European Debt Crisis including ban on naked Short Selling on selective instruments by Germany led to flight to safety, triggering down the US, UK yields. US Treasury yields also fell due to higher than expected unemployment rate. On the last day of week, the 10-year benchmark bond 7.80 % 2020 settled at 7.37 per cent, a fall of 12 bps against last week close of 7.49 per cent. It touched its weekly low of 7.32 per cent. Global risk appetite battered after Germany banned naked short-selling on selective Euro Zone bonds, triggering fears that there may be more trouble from the region in the days to come.
Inflation Front

On the economy front, the inflation continues to worry government with both its indicative tools i.e. Wholesale Price Index (WPI) and Consumer Price Index (CPI) at double digit level. However, Planning Commission Deputy Chairman asserted that India’s Inflation as measured by WPI may fall further in coming 2-3 months. The market is expecting that the softening of yields including softened inflation numbers in coming months may prompt RBI to stall its exit from accommodative monetary policy. Earlier, the RBI has indicated that they will continue to exit from accommodative monetary measures on a regular basis in the face of demand led pressure on inflation. India’s annual inflation rate based on CPI for Rural Labourers fell to 14.96 per cent in April from 15.52 per cent in March. Primary articles inflation also cooled down to 16.19 per cent in the week ended May 08 from 16.76 per cent a week earlier, however, the food articles inflation jumped to 16.49 per cent from 16.44 per cent in the previous week.
Bonds Supply

The government auctioned bonds worth Rs. 13,000 Cr which were subscribed fully with no devolvement to Primary Dealers. The auctioned bonds were 7.02% 2016, 8.20% 2022 and 8.26% 2027 for amounts of Rs. 5,000 Cr, Rs. 5,000 Cr and Rs. 3,000 Cr respectively. The cut-off yields came in at 7.29 per cent, 7.64 per cent and 7.97 per cent respectively. The bid to cover ratio in 8.26% 2027 were around 2.5 times while remaining bonds witnessed subscribing little below 2 times. Moreover, the auctions of these relative liquid bonds added an increasing interest among dealers and buyers. The government also issued 28-day Cash Management Bills (CMB) at an average yield of 3.9225 per cent.
Liquidity Front

Liquidity as measured by bids for reverse repo/repo in Liquidity Adjustment Facility (LAF) remained comfortable. The reverse repo bids averaged Rs. 42,779 Cr from Rs. 28,749 Cr in the previous week. The liquidity may be under strain following the FIIs outflows in term of Portfolio Outflows and payouts for 3G auction bids. The average call rates and repo rates softened to 3.72 per cent and 3.40 per cent from 3.79 per cent and 3.47 per cent a week earlier respectively.
Corporate Bonds Front

Corporate Bonds saw spread closing up. Five and Ten year’s benchmark AAA spreads closed up by 3 bps at 80bps and 109 bps levels respectively. The ten year AAA bond traded at a yield of around 8.60 per cent, lower from 8.68 per cent observed last week.

Bond yields laddered to 8 per cent level on devolvement

Highlights
• Benchmark bond 6.35% 2020 yield touched to 8.01 per cent on account of devolvement* in first week auction
• Primary dealers had to devolve Rs. 448 Cr. of 6.35% 2020 paper
• Food inflation rose to 14.50 per cent for data on Mar 27, 2010 against 13.86 per cent observed a week before
• Limits for Ways and Mean Advance (WMA) set at Rs. 30,000 Cr. for first half of FY and Rs. 10,000 Cr. for second half of FY
• Inflationary pressures (data to be available next Thursday) and Industrial Output data to influence the policy review due on April 20, 2010; inflation likely to be in double digits
• Market to witness an auction of Rs. 13,000 Cr. on Government Securities and Rs. 5,800 crore of State Development Loans (SDL) this week

*Devolvement - is a mechanism used by Reserve Bank of India as part of its monetary policy to counter the volatility in the price of Government Securities. Under this mechanism Primary dealers would have to absorb the underwritten amount, when the bid prices are unacceptable to the RBI.

Views & Recommendation:

• The weekly bond issuances are likely to impact the bond prices in a greater way; any further devolvement will put pressure on bond yields.
• Liquid Funds and Ultra Short Term Funds (erstwhile called as Ultra Short Term Funds) would see its yields rising from the current yield as shorter end of yield curve is likely to move up in near future once the policy rates go up.
• Investors having longer investment horizon (more than 2 years) should wait for yields to reach to 8.25-8.5 per cent level and can then invest in Income Funds.

Broad Perspective:

The week started with a cooling in bond yields; the 10-year benchmark 6.35% 2020 G-Sec slipped to 7.80 per cent on Monday, down by 5 bps over its last week closing. However, the sentiments went against the market and the yields rose to its three week highs ahead of first week auction of Rs. 12,000 crore and monetary policy tightening to contain high inflation.
The auction results disappointed the market and the benchmark yield passed 8 per cent mark to close at 8.01 per cent on account of devolvement. It touched to 8.03 per cent level, its highest in more than 17 months and a level it touched on Mar 22, 2010. The auctioned bonds got timid response and primary dealers had to devolve Rs. 448 crore of 6.35% 2020 paper. RBI set the cut-off yield of 7.9645 per cent for the 6.35% 2020 bonds. The other bonds were fully subscribed amidst high demand. Both received demands for more than two times. Due to devolvement, primary dealers demanded high cut-off yields. This week, the choice of securities will decide the momentum of bond yields and primary dealers will demand higher underwriting fees and higher yields in fear of devolvement of securities. Moreover, the subdued response on 6.35% 2020 bond is putting pressure on its existence as the benchmark yield and traders have been demanding for a new benchmark so that they could concentrate on the movement on interest rates instead of choice of a benchmark bond.
Inflationary pressures continue to remain intact; food prices accelerated for second straight week. The inflation based on primary articles rose to 14.50 per cent for the week concluding on Mar 27, 2010 against 13.86 per cent observed a week before. Industrial output data for February due on Monday and March inflation data on next Thursday are the factors which will decide the direction of RBI Policy review due on April 20, 2010.
Liquidity as measured by bids for reverse repo/repo at the Liquidity Adjustment Facility auction went to an average level of Rs. 1 lakh crore against Rs. 2,000 crore reported last week. Overnight rates also remained at the level of reverse repo rates due to high liquidity in the system.
However, Corporate Bonds yields saw an increased activity in the trading circles. Its spread over its counterpart G-Sec slipped in all categories. The 5-year and 10-year corporate bond spread over its counterpart G-Sec slipped to 76 bps and 63 bps from 81 bps and 82 bps respectively. The 10-year Corporate Bond closed at 8.80 per cent for the week concluding on April 09, 2010.
RBI set the limit for Ways and Mean Advance (WMA) at Rs. 30,000 crore for first half of fiscal year (April to September) and Rs. 10,000 crore for second half of fiscal year (October to March). WMA is a window through which the government borrows from RBI to meet mismatches between payment and receipts. Any borrowing within the WMA limit is done at Repo rate and over the WMA limit, it is done at Repo plus 2 per cent.

Yields to reel under inflationary pressures; rate hikes imminent

Highlights:

• Government borrowing schedule of massive Rs. 4.57 lakh crore declared; 63 per cent of total borrowings are front-loaded in first half of fiscal year 2010-11.


• On an average, the weekly borrowing would be in the range of Rs. 11,000 to Rs. 13,000 crore; the May month may witness the maximum borrowing of Rs. 65,000 crore with minimal borrowing of Rs. 22,000 crore in September.


• No Open Market Operations (OMOs) transactions declared; unlikely to put any pressure on yields due to sufficient liquidity.


• The week saw a sudden yearend decline in bond yields following the borrowing schedule declaration; unlikely to sustain the spurt in bond prices.


• Inflationary pressures to continue putting pressures on bond yields.


• The 10-year benchmark G-Sec 6.35 % 2020 to trade in the range of 8-8.5 per cent for most of the year.


• There was a combined transaction of Rs. 9,540 crore under Repo Facility in the last 3 days of Fiscal Year 2009-10.


• The G-Sec spread between 1-5 years have widened to 238 bps from 227 bps in the previous week.

Views & Recommendation:

·         For few weeks, the market may absorb the bond issuances without any impact on yields but in long term, the bond yields may witness upward revisions.

·         The short-tenure bonds would be in demand in the month of April and May in the current fiscal year due to negligible issuances. This may lead to unexpected hike in prices of short to medium term papers. An opportunity lies ahead in booking profits in short-to-medium term bonds/Income Funds/Short Gilt Funds after a couple of months.

On return basis, Tata G S S M F – Growth (6.67%), UTI G Sec Fund – STP – Growth (5.06%) among others has been front runners under Short-term Gilt Funds in two-year category. 

·         Liquid Funds and Ultra-Short term Debt Funds (erstwhile called as Liquid-Plus Funds) will continue to see inflows as investors would continue putting their surpluses for a short duration.

Broader Perspective:

The market reacted positively on the announcement of Government Borrowing Schedule; about 63 per cent of total borrowings (Rs. 2.87 lakh crore) are front-loaded in the first half of fiscal year 2010-11. Thus, it would prevent crowding out for private firms as post-October used to be busy borrowing month for them. The market will see an average weekly auction of Rs. 11,000 – Rs. 13,000 crore. The benchmark bond 6.35 per cent 2010 yield saw some swings.  The yield fell from 7.85 per cent to as low as 7.74 per cent before closing at 7.85 per cent level again. The 10-year benchmark G-Sec price closed at Rs. 89.90 down from Rs. 90.30 level as on Mar 30, 2010. Bond Prices and Yields move in opposite direction.

The high inflationary pressure is on the top agenda of policy makers as they are closely scrutinizing to negate its effects on yields since it would increase their borrowing costs. The inflation as measured by Wholesale Price Index (WPI) has already touched 9.89 per cent for the month of Feb 2010 and the March figures may touch the double digit. Though the government officials are of the view that inflation would drop down in couple of months citing the high base effect and falling food prices as the prominent reasons, it will continue haunting on non-food sides. The high crude prices including the high petrol and diesel prices for EURO IV vehicles will add pressures to inflation further.

The market may factor into the weekly bond supply and will see a smooth transition of bonds for first few weeks but the yields may harden in the weeks to come citing the absence of any Open Market Operations (OMOs) from the government side.

The other bonds 7.02% 2016 and 7.32% 2014 saw yields moving up 13 bps and 1 bps to 7.59 per cent and 7.25 per cent levels. Corporate bonds also saw yields dropping down. The shorter end of the curve saw yields falling piercingly after March-end liquidity worries went out of the system. The last three days of the fiscal year 2009-10 saw a total repo transaction of Rs. 9,540 crore under Liquidity Adjustment Facility (LAF). The liquidity as measured by Reverse Repo transaction under Liquidity Adjustment Facility (LAF) remained tight with an average volume of Rs. 4,027 crore.

SEBI’s ruling on Mark-to-Market may shun the attractiveness of Ultra-short term funds

Since the SEBI made mandatory for Liquid Fund managers to invest in papers with maturity of up to 91 days only, the Liquid Funds lost sheen among institutional investors due to reduced portfolio returns. This allowed the market participants to shift its focus to Ultra Short Term Funds (erstwhile called as Liquid-Plus Funds). Thanks to superior returns and tax benefits over Liquid Funds, Ultra Short term funds have found a favour among all class of investors.

However, the market watchdog SEBI still not very confident about the credit stability in the market issued another directive asking all mutual funds to value money market and debt securities with maturity over 91 days (or with maturity up to 182-days) on a mark-to-market basis with effect from July 01, 2010. The ruling will require all fund managers to factor in any movement in securities prices on a daily basis to calculate the Net Asset Value (NAV) of fund. The new valuation method may increase the volatility of Ultra Short Term Funds while Liquid Funds being shorter tenure funds will be less volatile. Currently securities having maturities over 182 days are already valued at daily weighted average (mark-to-market) method. The move will ensure that the Liquid Funds and Ultra Short Term Funds are undeniably liquid by asking them to be valued in a more transparent manner.

Ultra short term schemes which comprise 40 per cent of Indian Mutual Fund industry’s asset under management (AUM) of Rs. 7.59 lakh crore have been fetching returns in the range of 5-5.5 per cent having an edge over its sibling Liquid Funds fetching returns in the range of 4-4.25 per cent. The debt instruments held by Ultra Short Term Funds (or Liquid-Plus Funds) have a longer tenure i.e. the average maturity of these funds is comparatively higher than that of Liquid Funds. Long term papers (over 91 days) help fund managers to generate extra returns over short term papers (up to 91 days). Recently the RBI hiked the CRR by 75 basis points which increased the returns on Commercial Papers and Certificate of Deposits by around 100-150 basis points.

In the last few months, there have been continuous net outflows from Liquid Funds due to high dividend tax structure and restrictions to invest in papers having maturities up to 91 days only. Liquid Funds charge a dividend distribution tax (DDT) of 28 per cent unlike in Ultra Short Term Funds where the DDT is 14 per cent for individual and 22 per cent for corporate, thus, clearly giving a tax advantage of 8 per cent. Treasury Officials, CFOs etc prefer Liquid Funds and Ultra-Short Term Funds over Banks’ Fixed Deposits where interest income is charged at 33 per cent.

By issuing out the current directive, the regulator SEBI wants to make sure that the Oct 2008 Credit Crisis is not repeated where the RBI has to open a lending window for Mutual Funds for a limited period to ease out the crisis. However, the industry will continue to enjoy additional returns in Ultra Short Term Funds, though at a slightly higher risk as long as the tax-arbitrage is in existence over Liquid Funds and banks’ Fixed Deposits. The market will actively watch the upcoming Annual Budget on Feb 27, 2010 where the government may take away the tax arbitrage in Ultra Short Term Funds to make sure that Banks’ FDs are actively used for placing excessive unused funds, thus, bringing out a kind of stability in the credit market.

RBI exits from expansionary policies

The domestic economy has started experiencing its feel-good factor with the encouraging numbers from all ends. However, the global economic outlook scripts a different picture. The abundance liquidity, inflationary pressures and week credit off-take forced the central bank to initiate some precautionary steps.

Keeping in mind to provide a balanced approach to our coupled economy, the Reserve Bank of India (RBI) in its second-quarter review of monetary policy 2009-10 maintained its status-quo on its lending and borrowing rates by keeping repo and reverse-repo rates unchanged at 4.75 per cent and 3.25 per cent respectively. It has also kept the Cash Reserve Ratio (CRR), the portion of deposits which the commercial banks need to keep with the RBI unchanged at 5 per cent. However, the bank has hiked the Statutory Liquidity Ratio (SLR), the amount which the commercial banks need to maintain in the form of cash, government approved securities (G-Secs) and/or gold before providing credit to the borrowers, to 25 per cent from 24 per cent effective from Nov 07, 2009 which will suck up over Rs 30,000 crore from the system. The central bank also aims to reduce the surplus liquidity and fight the higher inflationary expectations, which have been building up following a deficit monsoon (22% deficit) causing an increase in prices of food articles and food products.

The RBI has also revised the inflation target from 5 per cent to 6.5 per cent. The inflation has increased from -0.12 per cent to 1.21 per cent within a span of six weeks, thus, reflecting a rise of more than 1 per cent. It has also kept the GDP target unchanged at 6 per cent with an upward bias.

The RBI has responded in a way so that its growth and inflationary targets are met well within their target limits as set and also bridge the fiscal gap by initiating the first phase of its exit from expansionary policy. It has ended the forex swap facility for banks and cut the export credit refinance facility to 15 per cent, the level seen in pre-crisis time from the current level of 50 per cent. It has also ended the special repurchase window for banks, mutual funds and NBFCs with immediate effect.

Following the announcements by RBI, the domestic markets have responded negatively. The barometer Sensex tanked 386 points on profit booking across all sectors except IT companies. The BSE realty index and metals were heavily battered slipping 6.24 per cent and 5.43 per cent respectively. On the debt front, the ten year G-Sec yield slipped from 7.41 per cent to 7.31 per cent, a gain of 0.1 per cent or 10 basis points.