Short-term rates remain high ahead of RBI policy review

Overnight call money rates are hovering above the policy rate, while three-month commercial paper rates are now nearly 100 bps above the December 2015 average.

Written by George Mathew | Mumbai | Published: February 1, 2016 12:23:01 am
RBI, raghuram rajan, RBI policy review, economy news, short term rates RBI governor Raghuram Rajan. (Express Photo by Prashant Nadkar)

The sharp rise in short-term rates could pose a challenge for Reserve Bank Governor Raghuram Rajan, who is scheduled to unveil the bi-monthly monetary policy review on Tuesday. Most analysts and economists expect the RBI to hold rates.

Overnight call money rates are hovering above the policy rate, while three-month commercial paper rates are now nearly 100 bps above the December 2015 average. The central bank has also rejected all bids at (91-day) a treasury-bill sale for a second time this month. State development loans (SDL) rates have gone up from 8 per cent in September to around 8.40 per cent and 10-year benchmark rates are in the 7.80 per cent range as against 7.60 per cent four months ago.

While analysts largely expect the RBI to hold the repo rates till the Union Budget announcement, they anticipate the RBI to provide indications about open market operations (OMO) to boost liquidity. “The repo rate has come down by 125 bps to 6.75 per cent since January 2015, whereas the yield of sovereign paper remained at the same level. The situation has further been aggravated in the last few months, bond yields have indeed risen secularly, albeit on account of multiple factors,” said Bansi Madhavani, analyst, India Ratings.

In the run-up to next week’s Reserve Bank of India’s policy review, domestic liquidity conditions have remained tight. “Persistent intervention to stabilise the currency, capital outflows and slower government spending have left liquidity in a deficit mode since Q4FY15. This shortfall was further aggravated by rise in external volatility this month, on the back of $1.6 billion worth foreign equity outflows. A strong start in debt inflows has also fizzled out in recent sessions,” said Radhika Rao, Economist, DBS Bank Ltd.

This in effect dilutes the impact of the accommodative policy stance and risks slowing policy transmission further, Rao said. Banks have been slow to pass on changes in the policy rates, while money markets had eased by a bigger margin. “However the recent liquidity strain has also pushed up money market rates, as highlighted above. Long-term bond yields are also off their back,” Rao added.

India Ratings said higher government cash balance — average daily balance Rs 104,000 crore for January 2016 — and intervention by the RBI to sell dollars (estimated at US $ 5bn for the month) have led to tightness in inter-bank liquidity, contributing to overall elevated yields. State bonds have begun experiencing the supply overhang and heightened risk from the possible large issue of DISCOM bonds. The rise in SDL rates is actually exerting pressure on other segments through substitution effects, it said.

However, Nomura which has come out with Nomura RBI Policy Signal Index (NRPSI) is predicting more easing, which is consistent with the RBI’s accommodative policy stance. “In our baseline, we expect the RBI to deliver a final 25 bps rate cut in its post-budget policy meeting in April 2016. However, an earlier inter-meeting cut cannot be ruled out,” it said.

“We continue to call for a 25 bps repo rate cut on February 2. First, inflation should meet Governor Rajan’s under 6 per cent January 2016 mandate. Food prices are peaking off in January. Second, growth remains weak. Third, a RBI rate cut will support the rupee by attracting foreign portfolio inflows. Fourth, the fiscal deficit is well under control. Finally, a high risk-free rate also prevents lending rate cuts,” said Bank of America Merrill Lynch economists Indranil Das Gupta and Abhishek Gupta.

The central bank is expected to provide some relief through additional bond buybacks in the near-term. “Expectations for more permanent injection of liquidity through reserve ratio cuts are likely to rise as the policy meeting nears,” Rao said.

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