Borrowing under the Marginal Standing Facility (MSF) is going up, as I’ve predicted. Now at more than 55,000 cr. (550 billion) we are in danger of not having any policy work for us at all.
Repo is limited to about 38,000 cr. (380 bn) due to RBI’s July 15 directive. MSF borrowing is at 10.25% which is considerably higher than the 7.25% repo comes at.
Remember that cash management bills have been auctioned recently and have yielded as much as 12.27%. Even if banks don’t need MSF, they can borrow overnight at 10.25% and get a 27 day bill at 12+%, keeping the spread. (The Spread, on Rs. 11,000 cr., is about 1.75% or nearly Rs. 200 cr. of “free” profit)
This profit is temporary. If the aim is to cut liquidity, RBI will have to raise rates eventually. Even long term bonds are trading at 1% above the repo rate, while short term bonds are trading 4% above. The raising of a rate will provide a signal that the RBI wants to cut liquidity.
Why cut liquidity when you have a growth problem? Essentially every extra ounce of liquidity available is fuelling inflation. Keep liquidity tight and rates high until inflation has been tamed. A great banker called Volcker did this in the late 70s and 80s, and inflation remained in control for over a decade afterwards (in the US). I will forgo the next few years if it means a phenomenal ride over the subsequent ten. But I’m increasingly alone in this.