 "RBI's shock therapy: Expect more tightening if short-term rates ease")
In a clear signal that money wouldn’t be available cheaply, the Reserve Bank of India (RBI) accepted bids for the auction of treasury bills at about-six-year-high yields. The market expects in case of a sign of easing liquidity, which would help rates fall, RBI might announce more measures.
On Tuesday, the central bank decided to cut individual banks’ borrowing under the liquidity adjustment facility (LAF) by half. This would mean if banks want more funds, they would have to borrow from the marginal standing facility (MSF) at 10.25 per cent. Also, lenders were asked to maintain 99 per cent of cash reserve ratio on a daily basis, against 70 per cent previously. These measures were seen as equivalent to raising the cash reserve ratio (CRR) by 50 basis points.
Market players said RBI wanted overnight rates at around the MSF rate and it would take steps to ensure the rates stay high. On Wednesday, the overnight call rate touched 10.15 per cent, before easing to about seven per cent by the end of the day.
“RBI may still be concerned about the un-hedged speculative forex exposures of corporates and by tightening liquidity at the individual bank level, it hopes to further choke speculative forex positions by corporates,” Nomura said in a report to clients.
Last week, after announcing the first set of steps to tighten liquidity, RBI had cancelled the T-bill auction; it was felt the central bank wasn’t comfortable with the high short-term rates. This had a comforting impact on overnight rates, which fell to seven per cent. According to market players, this prompted RBI to further tighten liquidity.
Last year, the central bank had raised the export credit refinance (ECR) limit from 15 per cent to 50 per cent, a move that injected Rs 30,000 crore into the system. Till the liquidity-tightening measures were announced, banks were drawing about Rs 5,000 crore from the ECR window. In the last week, bank borrowings have risen to Rs 20,000 crore from this facility. Banks borrow funds from the facility at the repo rate, which is 7.25 per cent. “If RBI wants to make all fund sources dearer, there is a case for raising the ECR rate to the marginal standing facility rate,” said a senior official from a foreign bank.
Another possibility is more auctions of cash management bills to suck out liquidity. On Thursday, Rs 6,000 crore of cash management bills would be auctioned to further soak up liquidity.
According to analysts, banks that are more dependent on bulk deposits would be hurt, as now, the short-term rate would rise.
Some private sector banks would be hit harder by the liquidity-tightening measure. On Wednesday, the stocks of two private sector lenders—YES Bank and IndusInd Bank—took a beating. YES Bank fell 12.63 per cent, while IndusInd Bank shares fell 8.46 per cent.
“The immediate impact of liquidity squeeze is more on private banks, as they are more dependent on bulk deposits, while the reliance of public sector banks on bulk deposits has significantly eased after the finance ministry directive last year,” the Karvy report said.
Banks treasury operations would also be severely impacted, with bond yields hardening.
Following last Monday’s action, the yield on the 10-year benchmark government bond rose 50 basis points. On Wednesday, the yield on the bond closed at 8.41 per cent, compared with the previous close of 8.17 per cent. Banks have borrowed Rs 28,835 crore under RBI’s LAF window, as most banks have covered their positions, much ahead of the reporting Friday.
Banks recorded trading gains in the fiRst quarter due to favourable yield movement and were expecting this to continue in the second quarter. BankeRs said they had expected trading gains would offset the hit from the provisioning requirement for pension and restructured advances. From June 1, banks have to provide five per cent, against the current 3.5 per cent, for fresh loan recasts.
Subbrao’s Bernanke-like dilemma
While the central bank has shown resolve for a tighter liquidity regime by accepting higher bids for T-bills, the question is how long can the situation continue? Though RBI has said these steps are temporary, it hasn’t indicated any timeframe. Banks have indicated if such an environment continues for four-six weeks, profitability could come under severe pressure.
However, an exit from the tight liquidity policy could pose a dilemma for the central bank. “An indication from the US Federal Reserve regarding tapering of the asset purchase programme has increased volatility in the market. As a result, the authorities have become cautious in giving forward guidance,” said the treasury official at a bank.
This may be true for RBI, too, when it starts contemplating doing away with the liquidity restrictions. “For example, for investoRs who purchased T-bills at a high yield, any indication of liquidity easing would soften the yield, which would make them exit. We may also see the outflow of foreign funds from debt, once the easing starts. This isn’t positive for a country with a high current account deficit (CAD),” said a banker.
Experts said more stable policy measures that addressed CAD on a more permanent basis such as raising funds through sovereign bonds, should be taken. “What can RBI do? We expect it to finally take more proactive steps to arrest the falling CAD cover. Issuing NRI (non-resident Indian) bonds or sovereign debt offeRs readymade fixes. Other medium-term options include raising foreign institutional investor (FII) debt limits, foreign direct investment limits and FII equity limit in public sector banks,” said Indranil Sengupta, India economist, Bank of America Merrill Lynch.
The current account deficit – which was 4.8% in the last financial year – was at record high and much above the central bank’s comfort zone of 2.5%. The country’s foreign exchange reserves – at $ 280 billion – would cover import for about 7 months, below 8-10 months which is seen for a stable currency.
On Tuesday, the central bank decided to cut individual banks’ borrowing under the liquidity adjustment facility (LAF) by half. This would mean if banks want more funds, they would have to borrow from the marginal standing facility (MSF) at 10.25 per cent. Also, lenders were asked to maintain 99 per cent of cash reserve ratio on a daily basis, against 70 per cent previously. These measures were seen as equivalent to raising the cash reserve ratio (CRR) by 50 basis points.
Market players said RBI wanted overnight rates at around the MSF rate and it would take steps to ensure the rates stay high. On Wednesday, the overnight call rate touched 10.15 per cent, before easing to about seven per cent by the end of the day.
“RBI may still be concerned about the un-hedged speculative forex exposures of corporates and by tightening liquidity at the individual bank level, it hopes to further choke speculative forex positions by corporates,” Nomura said in a report to clients.
Last week, after announcing the first set of steps to tighten liquidity, RBI had cancelled the T-bill auction; it was felt the central bank wasn’t comfortable with the high short-term rates. This had a comforting impact on overnight rates, which fell to seven per cent. According to market players, this prompted RBI to further tighten liquidity.
Last year, the central bank had raised the export credit refinance (ECR) limit from 15 per cent to 50 per cent, a move that injected Rs 30,000 crore into the system. Till the liquidity-tightening measures were announced, banks were drawing about Rs 5,000 crore from the ECR window. In the last week, bank borrowings have risen to Rs 20,000 crore from this facility. Banks borrow funds from the facility at the repo rate, which is 7.25 per cent. “If RBI wants to make all fund sources dearer, there is a case for raising the ECR rate to the marginal standing facility rate,” said a senior official from a foreign bank.
Another possibility is more auctions of cash management bills to suck out liquidity. On Thursday, Rs 6,000 crore of cash management bills would be auctioned to further soak up liquidity.
According to analysts, banks that are more dependent on bulk deposits would be hurt, as now, the short-term rate would rise.
Some private sector banks would be hit harder by the liquidity-tightening measure. On Wednesday, the stocks of two private sector lenders—YES Bank and IndusInd Bank—took a beating. YES Bank fell 12.63 per cent, while IndusInd Bank shares fell 8.46 per cent.
“The immediate impact of liquidity squeeze is more on private banks, as they are more dependent on bulk deposits, while the reliance of public sector banks on bulk deposits has significantly eased after the finance ministry directive last year,” the Karvy report said.
Banks treasury operations would also be severely impacted, with bond yields hardening.
Following last Monday’s action, the yield on the 10-year benchmark government bond rose 50 basis points. On Wednesday, the yield on the bond closed at 8.41 per cent, compared with the previous close of 8.17 per cent. Banks have borrowed Rs 28,835 crore under RBI’s LAF window, as most banks have covered their positions, much ahead of the reporting Friday.
Banks recorded trading gains in the fiRst quarter due to favourable yield movement and were expecting this to continue in the second quarter. BankeRs said they had expected trading gains would offset the hit from the provisioning requirement for pension and restructured advances. From June 1, banks have to provide five per cent, against the current 3.5 per cent, for fresh loan recasts.
Subbrao’s Bernanke-like dilemma
While the central bank has shown resolve for a tighter liquidity regime by accepting higher bids for T-bills, the question is how long can the situation continue? Though RBI has said these steps are temporary, it hasn’t indicated any timeframe. Banks have indicated if such an environment continues for four-six weeks, profitability could come under severe pressure.
However, an exit from the tight liquidity policy could pose a dilemma for the central bank. “An indication from the US Federal Reserve regarding tapering of the asset purchase programme has increased volatility in the market. As a result, the authorities have become cautious in giving forward guidance,” said the treasury official at a bank.
This may be true for RBI, too, when it starts contemplating doing away with the liquidity restrictions. “For example, for investoRs who purchased T-bills at a high yield, any indication of liquidity easing would soften the yield, which would make them exit. We may also see the outflow of foreign funds from debt, once the easing starts. This isn’t positive for a country with a high current account deficit (CAD),” said a banker.
Experts said more stable policy measures that addressed CAD on a more permanent basis such as raising funds through sovereign bonds, should be taken. “What can RBI do? We expect it to finally take more proactive steps to arrest the falling CAD cover. Issuing NRI (non-resident Indian) bonds or sovereign debt offeRs readymade fixes. Other medium-term options include raising foreign institutional investor (FII) debt limits, foreign direct investment limits and FII equity limit in public sector banks,” said Indranil Sengupta, India economist, Bank of America Merrill Lynch.
The current account deficit – which was 4.8% in the last financial year – was at record high and much above the central bank’s comfort zone of 2.5%. The country’s foreign exchange reserves – at $ 280 billion – would cover import for about 7 months, below 8-10 months which is seen for a stable currency.