The Event:
The RBI yesterday has announced various measures from perspective of managing external account and rupee volatility. These are as follows:
1. Hiked marginal standing facility (MSF) rate by 200 bps to 10.25%. This is the penalty rate at which banks can borrow over repo rate (was at 100 bps over repo so far).
2. Restricted borrowing under LAF to 1 percent of NDTL or approx INR 75,000 Crs.
3. Will conduct OMO sale (sell securities to market and mop up liquidity) of INR 12,000 Crs on July 18.
Impact:
The intent seems to be to tighten INR supply and hike carry cost in order to stabilize the currency and possibly to attract yield chasers to domestic market. However, near term impact could be quite disruptive. Call rates may over a period of time rise towards the MSF rate and yield curves should get significantly inverted. OMO sales will create additional government bond supply in environment of tight funding costs which should cause yields to rise. Finally, corporate bond spreads may potentially widen significantly as market may start worrying about liquidity in these assets. From a banking system perspective this sets back the whole transmission process. Banks had just begun reducing base rates further on prodding by the finance minister. This will leave them severely scratching their heads.
Implications:
The move clearly shows that RBI is out to achieve financial stability at the cost of everything else. It is indeed quite significant that it has chosen to take these measures (which effectively significantly tighten cost of funds) in an environment where growth is so weak. However, unlike an explicit rate hike, the method adopted allows flexibility to revert to earlier scenario almost overnight, once the central bank judges external risks to be manageable.
While a short term disruption is to be expected due to these measures, they also create a large medium term opportunity for bond funds. This is because the measures undertaken are bound to create a substantial drag on growth in an environment where growth is already weak. Also, it should substantially improve valuations on the curve thereby making the bond play that much more attractive once these steps are reversed. Having said that we would in all probability want to wait and watch in the near term till the market stabilizes.
The RBI yesterday has announced various measures from perspective of managing external account and rupee volatility. These are as follows:
1. Hiked marginal standing facility (MSF) rate by 200 bps to 10.25%. This is the penalty rate at which banks can borrow over repo rate (was at 100 bps over repo so far).
2. Restricted borrowing under LAF to 1 percent of NDTL or approx INR 75,000 Crs.
3. Will conduct OMO sale (sell securities to market and mop up liquidity) of INR 12,000 Crs on July 18.
Impact:
The intent seems to be to tighten INR supply and hike carry cost in order to stabilize the currency and possibly to attract yield chasers to domestic market. However, near term impact could be quite disruptive. Call rates may over a period of time rise towards the MSF rate and yield curves should get significantly inverted. OMO sales will create additional government bond supply in environment of tight funding costs which should cause yields to rise. Finally, corporate bond spreads may potentially widen significantly as market may start worrying about liquidity in these assets. From a banking system perspective this sets back the whole transmission process. Banks had just begun reducing base rates further on prodding by the finance minister. This will leave them severely scratching their heads.
Implications:
The move clearly shows that RBI is out to achieve financial stability at the cost of everything else. It is indeed quite significant that it has chosen to take these measures (which effectively significantly tighten cost of funds) in an environment where growth is so weak. However, unlike an explicit rate hike, the method adopted allows flexibility to revert to earlier scenario almost overnight, once the central bank judges external risks to be manageable.
While a short term disruption is to be expected due to these measures, they also create a large medium term opportunity for bond funds. This is because the measures undertaken are bound to create a substantial drag on growth in an environment where growth is already weak. Also, it should substantially improve valuations on the curve thereby making the bond play that much more attractive once these steps are reversed. Having said that we would in all probability want to wait and watch in the near term till the market stabilizes.
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