What is your takeaway from the RBI’s speech? It feels like that the banks are not reacting quite positively. We are seeing a bit of a slip there.
This policy is as per the expectations of the market and I will call it an insurance policy. RBI had the choice of raising rates or not raising rates both would have been acceptable but they preferred to err on the side of caution and raised rates by 25 bps. They could have probably made the stance more neutral, more nuanced towards growth but they are taking it based on the data coming through.
Going forward for the market, the real challenge is the government’s borrowing programme. While an absolute number borrowing programme is similar to the current year, next year, the liquidity will get tightened. We believe that without RBI’s active involvement, this borrowing programme could have an impact on yields. So it will be interesting to see how RBI conducts its open market operations and their assurance in this policy that they will conduct operations on both sides of the left, maybe a step in the right direction.
More than the monetary policy, now markets will be more focussed on what is the first up borrowing programme and what kind of involvement RBI has including open market cooperation to ensure that borrowing program passes smoothly.
How much of a difference will the policy announcement of a facility for lending and borrowing GSecs, really make for liquidity? As far as my understanding of GSecs market is concerned, there is enough liquidity in certain securities and there is virtually no liquidity in certain others. It is not as if there is a one uniform definition for liquidity in GSecs.
Today is the day where I am agreeing with you which is quite opposite to our past tradition. But on a serious note, RBI is taking a stance that if growth is suffering, we can always cut interest rates very quickly to support growth but if core inflation and headline inflation does not come under control and remain sticky, then we will have to raise interest rates far more.
So, might as well err on the side of caution, do a 25 bps increase and wait for that impact including the past interest rate hikes on inflation and see if the actual trajectory of inflation goes below 5.3% which is what they have projected for FY24. In some sense, past interest rate hikes seem to be working as the fourth quarter inflation number has been revised downwards. So hopefully, RBI is erring on the side of caution, giving them the elbow room to support growth when needed and yet bring down the inflation under control. From a liquidity point of view also, it is a kind of insurance policy. It assures banks that government securities which may not be easily tradable without impacting costs in the market. One can still access liquidity from the RBI window. This is more preparing for the FY24, where liquidity is likely to be tighter for the reasons which you explained earlier.Can you supplement the window of borrowing and lending? If it is vis-à-vis the RBI, then how much of a fair price determination market discovery process will you have as far as the pricing is concerned? Or will you have to buy at RBI dictated prices and rates?
You have the final aces in this game. They can use that to give price signal, they can use that to give price discovery to the market and many times we have seen that one r-bit trade creates the price level in that security. However, when you go for an auction kind of mechanism, you realise that the price discovery for a larger quantum is totally different and this is true especially at the long end where one or two trades on a pure r-bit basis raises or lowers yield, but the auction yield, primary auction yield is substantially different from secondary market yield.
RBI will be able to use this mechanism on both the sides price discovery as well as price signalling.
As far as yields are concerned, how worried are you about yields moving up quite sharply because we are going to see a decline from insurance companies and from mutual funds? We are not going to get that nominal bump up as far as GDP is concerned. How much pressure do you expect on yields? Will it cross that 7.4% and move up to 7.5-7.6%?
Yields will require RBI support. For all the reasons you mentioned, clearly there will be upward pressure on yield. The only thing which can contain yield is that this is probably one of the last rate hikes and inflation is coming down. Real interest rate will be positive for India in FY24 against 6.5% repo and 5.3% expected inflation; 1.2% real interest rate is not bad.
We may see some support coming in for yields at the end of 2023, beginning of 2024, if globally the interest rate cycle gets reversed. But undoubtedly, the market will be looking forward to RBI’s participation. They will look forward to RBI’s verbal signalling that this is Lakshman Rekha, do not cross yields above this. They will be looking forward to open market operations to give price signals or to absorb excess government supply.
In our opinion, RBI will have to probably intervene to the extent of anywhere between 10% and 15% of the government’s net borrowing programme next year so that yields do not cross the Lakshman Rekha.
