RBI Deepens And Widens Debt Markets In Lower Interest Regime
The RBI continued with its trademarked cautious version of
quantitative easing; in its latest review on February 3rd, 2015. The
Reserve Bank didn’t cut the headline policy rate, maintained, as in January, at
7.75%. And the CRR (Cash reserve ratio) stayed put at 4% too.
Market analysts still expect at least 100bps cut in the
‘repo rate’ through 2015, with some foreign analysts thinking it could be as
much as 150 bps. Others still think it will be 200bps, but spread over till the
end of 2016. This would represent a lowering of the policy rate to 6% by then.
This apparent stand-still mildly disappointed the stock
markets overall, though the Bank Nifty fell hard, the bonds and debt market
reacted with a thumbs down, along with the interest rate sensitive sectors.
This, even though most analysts did not expect a rate cut this time.
Governor Rajan indicated he expected a ‘solid’ budget’, and
‘high-quality fiscal consolidation’, going forward. It is true that the fiscal deficit is not yet
tamed, and the targets agreed to by the Government for this fiscal look
daunting. However, the PSU divestments ongoing will definitely help.
The CAD (Current Account Deficit) has fallen to 1.3% from
over 3% last year, thanks to the 50% drop in the price of petroleum; and this
is very encouraging for the lower interest rate regime. As is the CPI (Consumer
Price Index) number, bettered to under 8% in January 2015, and expected to go
to 6% or below, by January 2016.
So, to a great extent, the pace at which the headline
interest rate will be lowered by the RBI will depend on the Modi Government’s
reform agenda and early implementation of it. The RBI clearly plans to react to
the data rather than to lead it.
The RBI did however cut the SLR (Statutory Liquidity Ratio)
by 50 bps to 21.5% down from 22%. This is intended to free up some Rs. 40,000
crores in the hands of the banks, which RBI Governor, Raghuram Rajan, wants
lent by them to worthy borrowers.
The RBI noted however, that the commercial banks have not,
except for just three out of forty five, lowered their interest rates, after
the first 25 bps repo rate cut on January 15th. Bank profitability
has been under pressure, and many of them carry substantial non-performing assets
(NPA) on their books, including large monies lent to the under-performing
infrastructure sector.
The Government, on its part, is trying to get the
infrastructure projects, particularly in mining and power plants going again,
and is keen that some $19 billion held in cash reserves or near cash reserves
by PSU giants Coal India, ONGC, NTPC,
NMDC and BHEL, invest this money as soon as possible.
Coal India’s Chairman
Sutirtha Bhattacharya, soon after his Rs. 22,600 crore stake sale, has
indicated that it plans to invest substantially in railway tracks, wagons and
machinery to tap deep-lying reserves.
This is particularly appropriate and will pump up GDP growth,
because the FDI (Foreign direct investment) input for eight months of this
fiscal is only in the region of $18.88 billion, much below desired levels.
The largest money flow into India is in FII (Foreign Institutional
Investors) investment in Indian debt, where the Government bonds limit of $ 32
billion is fully subscribed, as is $ 32.5 billion of the $51 billion allowed
into corporate debt.
It is here that the RBI has made some changes to encourage
more investment. It has done away with a stipulation of a one year lock-in for
infrastructure oriented corporate debt in favour of a no lock-in but three year
residual maturity paper. This should help attract FII subscription up to the
$51 billion limit in corporate debt paper.
The RBI has also created a greater flexibility in the area
of hedging interest rates in the debt market. It now allows cash settlement in
interest rate futures (IRF) contracts on the medium term 5-7 year segment,
which is also the most highly traded. It earlier allowed FIIs into cash
settlements in the 10 year and 13-15 year Government Securities only.
The FIIs are clamouring
for higher limits for their permissible investment in Government Securities in
particular, but this is still pending.
Encouraged by our buoyant foreign currency reserves
($322.135 billion in January 2015), the RBI has also allowed both domestic and
FIIs to take positions up to $ 15 million in exchange traded currency
derivatives, per exchange, and without involving underlying exposure. This is
for the US dollar- Indian Rupee (INR). In other currencies, the Euro-INR, the
Pound Sterling GPB-INR and the Japanese Yen-INR, the domestic institutions and
FIIs have been allowed to take the equivalent of $5 million per exchange
without undertaking underlying exposure.
Players willing to take underlying exposure can take on larger exchanges
as well.
The RBI has further responded to a $6.8 billion increase in
foreign exchange reserves over just the last quarter, by increasing the
investment limit abroad, permitted per annum, for each Indian citizen, to $
250,000. This represents a $ 50,000 increase over the previous highest limit of
$200,000, curtailed to as little as $ 75,000 in 2013, when the CAD was going
out of control at the end of UPA 2.
(875 words)
February 3rd,
2015
Gautam Mukherjee
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