Actionable insights on equities, fixed-income, macros and personal finance Start 14-Days Free Trial
Actionable investing insights Get Free Trial

RBI Effectively Hikes Rates 2%, Sets limits on Repo usage.

At 10PM, way past RBI’s bedtime, there shows up an innocuous press release from the RBI. It has effectively slashed liquidity with (nearly) immediate effect, and in a roundabout way, increased interest rates.

MSF Rate Hiked to 10.25% and Repo Limit to 1% of NDTL

I know, this sounds like gibberish.

To the uninitiated, the RBI allows banks to borrow overnight from it at the “Repo” rate. (Currently this is 7.25%) The amount banks can borrow has been unlimited, as long as it can provide government securities as collateral. The RBI frowns (but doesn’t penalize) when repo borrowing crosses more than 1% of banks’ “Net Demand and Time Liabilities” (NDTL). To get a better idea of what NDTL is, please read Dheeraj’s excellent tutorial on these terms at Capital Mind.

You can think of NDTL as the total amount of deposits (it’s close to that). Currently, the system has about Rs. 75 trillion (75 lakh crore) rupees as NDTL.

Read more about the Marginal Standing Facility (MSF). In short, it’s like the Repo but for extremely desperate borrowing. The MSF Rate was at 1% above the “Repo Rate”. (So, currently 8.25%).

The MSF rate has been hiked to 3% above the repo rate – or 10.25% today.

And then, from Wed July 17, Repo based borrowing has been limited to 75,000 cr. Meaning, if banks want more, they have to go the MSF route. And within the 75,000 cr. limit, each bank will get a “pro-rata” allocation according to the amount they bid.

Finally, the RBI will conduct an OMO – Open Market Operation – by printing rupees to buy some securities to give banks some liquidity. Presumably it has sold dollars and needs to offset that.

RBI will conduct open market sales of Government Securities – effectively, taking rupees from banks and giving them government bonds it holds – which will further reduce liquidity.

(Apologies. I first read that as an Open Market Purchase, a typical OMO)

So what?

Good question.

Liquidity in the system, according to the RBI, is now ample. Banks have recently not borrowed a lot from the RBI. The MSF window has been entirely unused for a while.

Now, if banks do need to use that window, it’s gone. Their marginal rate is now the MSF rate which is 10.25%. This increases their cost when they need liquidity. Effectively in a tight cash situation, banks will have to pay more.

This will mean they will hike their interest rates for lending. Banks always respond quickly to RBI raising their costs, but slowly when the RBI does the reverse.

The RBI balance sheet will contract, and given that I have been advocating this for a while, I applaud the thought behind this. I just wish they didn’t have to do it desperately.


The Impact

  • An effectively higher interest rate will mean that growth will slow.
  • And that inflation will come down in the longer term.
  • The rupee may slow down its fall, temporarily. We could see a 58 print tomorrow.
  • But unless we see the foreigners bringing in more cash fast, the rupee slide will continue.
  • Banks, because of their sudden increase in borrowing costs, will feel the pain. And that will be reflected in stock prices too.
  • Bonds will fall in value (and rise in yields) to account for the effectively higher interest rates.

Already, ICICI Bank and HDFC Bank have fallen 1% in the US markets. I believe the bank index will fall tomorrow.

The 10pm announcement reeks of panic. But these steps are okay considering they didn’t impose restrictions on rupee selling or a ban on trading. The aim is to attract capital flows but panic cannot be an option!

Let’s see how the market opens tomorrow.

  • Sam says:

    No, my friend. RBI will conducting an OMO sale this time (not a purchase). Whoosh! More liquidity sucked out.
    P.S. Understand the urgency to release the post but please take care in the future.

  • Murty says:

    Again , we are a worried lot! It is not just about the stock market. The impact seems going to be worst ever. They all think they can contain inflation/ rupee devaluation etc. it is just a week back that the FM said nothing to worry about dollar appreciation. If it is true, why taking an overnight measure? I am sure Dr. Manmohan’s Post Docyoral study is yet to be finished. Academicians! Modi was right! We do not know how to make use of our research scholars

    • Kaka says:

      They are not academicians. Don’t give academia a bad name. Having a degree from a good institution neither means that they are academics, nor does it mean that they learnt something.

      • Murty says:

        Dear KakaJi,
        I do not know whether you are an academic, I did not gave a bad name to the academia. In fact, I have the highest regard to the pedagogical community, GURODEVOBHAVA! But are they truely GURU’s It is highly questionable. Because I saw the SYSTEM from very close quarters for almost 20 years, being part of the SYSTEM. You are right, having a degree from a good institute doesn’t mean high quality, the learning only begins after aquiring the degree.
        These days, the SYSTEM is diluted and rotten. Just look at the quality of research and the bunch of jokers that are called Doctorates. You can really do a qualitative research on the TYPE OF RESEARCH that is thrusted upon the society. Modi referred it well, by saying how much of this RESEARCH is being utilized! That is what I mean. Only DEGREE no GYAN, like they say in the SPRITE Ad.

  • mangoman says:

    Although you are milder than me, our views are almost the same.
    1. But now do you know whether banks are continuously borrowing more than the 75000 Cr set by the RBI? I mean how it will hurt the banks unless otherwise they are having to use MSF.
    Another interesting aspect I have observed yesterday wherein WPI inflation figures are released during market hours as it is perceived to be good news for market. Is it not amounting to fraud in government for they said they are going to release all these ( gdp, inflation and iip) after market hours?

  • charles says:

    Probably the right thing to do but subbarao s days in rbi are now numbered

    • He’s had to go anyway, no?

    • Shiva says:

      He is anyway scheduled to retire by Sep end and he never gave a damn to getting extensions/ currying FM’s favour. I remember the last time when just before getting an extension, he had jacked up rates much against the wishes of the FM. Still he got extended :). So this move effectively rules out any downward move on July 30 ( if any naive economist was still expecting the same). But I think the market is overreacting!!

  • mangoman says:

    So far these bankers were doing easy money business. Get some cheap money from RBI which is forced by corrupt UPA government and lend them to real estate brokers. When the repayment term comes they replan the loan repayment until idiot mangoman takes these loan as housing loan or whatever bull shit they call us. Those days are easy money are over. Now it is time to Indian bankers to do business as per the book. Identify the business analyse the margin and then lend. Since now most of the Indian business man turned brokers and not ready to accept a margin of anything less than 40% it would be a tough ask. Otherwise what can define that almost all top business house in India dabble in real estate?
    Ok. Now what? Since interest rates are going to go up it would be very interesting. Fraudsters who are ready to sell even their wives for a rate cut are going to get crushed in this financial sunami unless they understand what is real business is.
    It is sad that guys like businesses of Ratan Tata who never comes on broker channels to beg for a rate cut, is not doing that good. His tata steel and tata motors are not doing good. I feel for it. But that is what life it.
    Anyway Chidambaram will come on TV and will tell that what RBI has done is just a eye wash or hog wash. It is just a ploy to shore up the currency and bankers need not worry that the government and RBI will find some innovative ways to give money to real estate brokers supported by banks. Am I right?

  • Vidyanshu says:

    The MSF rate hike seems more like a signal than of any real utility. Its not unlike a canine in distress baring its teeth. On the NDTL and repo rate, it might have a marginal impact…All in all it looks like RBI is just trying to terrorise markets by sending signals. The impact of all this seems negligible in the short to mid term. On the other hand it seems like if the FII folks get the wrong signal then they might depart from the bond market and start unwinding their positions from Equity as well….So it might result in dollar outflows and markets reacting in panic, leading to a hike in INRUSD beyond 61 again. I get the feeling that RBI is desperate and totally out of ideas. This is a textbook move and not suited for the current environment.

  • Ashish Tiwari says:

    how will this step help in curbing fall of rupee? I didnt get? pls pardon my ignorance..