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Rajan Bites The Bullet, Raises Repo Rate 0.25%, Untwists Yield Curve

Dr. Raghuram Rajan has raised the repo rate (overnight borrowing rate for banks) by 25 basis points (0.25%) to 7.5%.

RBI repo rate history


Banks which were required to keep 99% of the Cash Reserve Ratio (CRR) at all times, are now required to keep a minimum of 95% which gives them some breathing room. (Average over the fortnight must be 100%). Currently banks are keeping around 3.18 trillion, about 5% more than the required 3.01 trillion, to avoid going under. This gives them room to reduce that by about 10,000 cr. (100 billion), which is effectively a saving of around 1,000 cr. a year (considering a 10% cost) for the banking system or Rs. 250 cr. a quarter.

CRR freedom helps banks keep less money interest-free at the RBI and they can invest it elsewhere.

He has also tried to unwind part of “Operation Knicker-Twist” (not their name) by the last governor, D. Subbarao.

The Marginal Standing Facility which was at 10.25% is now down to 9.5%. This means the “corridor” for borrowing more than 0.5% of NDTL (sum of all deposits, to simplify) is now 200 basis points (2%) above the repo rate.

Effective overnight rates are now 9.5% because repo is limited. There is no increase in the limit that banks can borrow under repo. (which is 0.5% of NDTL, currently that translates to 40,000 cr.)

That means short term rates come down 0.75% (from 10.25% to 9.5%) and longer term rates, pegged to the “intent” behind the repo, will go up. The yield curve that is currently ‘inverted’, will become more normal. I’ll call this “The Rajan Untwist”.

I’m now going to take some credit for a prediction (which I didn’t want to do) in my earlier post on “What Will Rajan Do Today?”. I had said:

  • Rajan should raise rates to control inflation. (But I doubt he will)
  • The liquidity tightening must continue to support the anti inflationary cause. But since they pitched it as a dollar-rupee control measure, it is unlikely to. So CRR might be eased (in terms of % maintained).
  • The MSF window might come down – Again, my view is to keep those rates high no matter what. From 10.25% we might see a 10% rate though.
  • I believe he must act on some of the other things he mentioned, like a freer rupee.
  • Also, on the “default” front, I hope Rajan introduces strict measures for banks to recognize and not evergreen defaulting loans. Very tough restructuring norms and penalties will help.

The last two aren’t addressed. The rest seem to be inline.

<end self-glorification>


  • 10 year yield was at 8.15% in the morning. Moved up to 8.45%. (Bond funds will lose money)
  • T-Bill yields are now around 9.8%, but lower than the 10-11% recently. But there’s not that much change today.
  • Bank CDs, which were firmly over 10%, are showing quotes below 10% now. (Ultra short term funds should have done well for today, but going forward, yields will come down)
  • USD-INR exchange rate has gone up from 61.7 to 62.3 as I write this. This is natural – the first fear is of equity markets coming down, and we don’t have complete freedom on foreign investors buying our bonds yet.
  • Banks are down more than 6%, and stock markets are down 3%.
  • TV analysts are saying good things and that we will recover, and that this is a temporary move down. That means this downmove could last considerably longer.

Remember this: The signal we are getting is that inflation is more important than growth right now. Which means that until CPI inflation shows considerable easing, we are likely to see more policy rate increases. This means credit growth will be curtailed, and that is bad for overall economic growth – this is a short-term negative for markets.

  • mangoman2012 says:

    Loved that the sparrow head idiot Pratip Chaudhuri snubbed by rGR.

  • mangoman2012 says:

    A big misread.
    Chidambaram thought Rajan as something else…
    Rajan underplayed until get the chair and after getting the chair he is showing who he is?
    Great..hats off to you sir…
    Please save the country from the crooks..
    cAn you also talk openly about the real estate mafia?

  • DJ says:

    Nice to get the rate cut on the short term and the rise in long term treasuries. Yield flattening should reduce risk and/or severity of recession. I guess banks, builders don’t like the rise in the long term rates, as that is what they will have to pay out, even though their short term borrowing and debt roll should be cheaper?
    The talk about inflation expectations was a also a nice and much-needed change. Glad that they have a 3 month committee by Urijit Patel to look into what to target. So, I guess his term can see more clarity on the measures and targets, over time. It was a bit annoying that he had to temper his hawkish language, because of the repetitive growth vs inflation badgering from the media.
    What I didn’t like is his ambivalence on some things like capital withdrawal limits, etc. He kept the door open on many of the constraints. And, his worry on the rupee volatility was a bit extreme. I thought he would be more unambiguous about the wrong-headedness of the short term measures. But, I guess he was being realistic. I didn’t think it was right for the RBI to categorically say that we are better off now at 62 as compared to 68 and to comment on specific issues like the Syria situation.
    I wish he didn’t say “I think” so much and replaces it with “we think..”. While I don’t have a problem with it, some fragile egos won’t be able to handle it…
    And, nobody asked for more details on his plan to review condition of banks, NPAs, etc. That should be the next important focus area now.

    • DJ says:

      Glad to see that Dr Ajay Shah is also critical (in his blog) of the stance adopted by Rajan on capital controls and exchange rate manipulation. Fully agree with him.

      • XYZ says:

        The current academic and professional opinion is that capital controls are the only way to protect one’s economy from the Fed’s QE. If a Chicago Boy is slightly ok with capital controls, then there must be something extremely important about them.

  • Gold Bug says:

    So where do we hide? Seems foreign funds (but they look expensive). IT/Pharma also seems expensive. Floating rate funds? or Arbitrage Funds? Can some one throw some light?

  • XYZ says:

    The Chicago Boy came through. It will be a hard currency policy. Expect a lot of pain.

  • px says:

    RgR, is a breath of fresh air, and has done what the prev RBI Gov couldnt ! Im amazed at why PC didnt give any comments… wonder if he tried giving his trademark diktats to RgR and Montek who took time to comment gave a guarded comment.
    He said that CPI inflation is among the main indicators he would monitor or some such thing today. Has he shown the political elite that he is his own boss ?
    SBIs P Chaudhuri said that SBI maintains a 10% buffer not 5% over CRR and has stated that the 10yr is not a real indicator as the govt hasn’t, of late sold any 10 yr paper in the market.
    Rates are going up if inflation stays up is my broad inference .
    What does a small man who holds 1. debt mf , mip mf , liquid mf do ?

    • DJ says:

      Do you know which maturities are usually used by the govt when auctioning gilts? Where does one get this information. I think there is a large gilt supply expected this year and I’d like to know which maturity it will be, mostly.

  • Px says:

    Raghuram Rajan has given PC such a shock that he didn’t even react ! That`s a first from a man who gave diktats to all and sundry !
    Sbi boss P Chaudhuri has stated that it maintains a 10% buffer and that that MSF is now the Repo for practical purposes due to the curbs.Will smaller banks benefit more from this policy?
    On interest rates where do u see the 1 to 5 yr deposit heading say by december ? Is it better to wait or book ur fds now ?
    On freeing rupee, how much can he do ? Finally the ball is in the court of the fiscally profligate PC and Madam Sonia.

  • mangoman says:

    SBI Chaudhuri is a paid slave for Chidambaram.
    In other words, Chidambaram talks through SBI chief. It is so obvious. But seeing SBI’s volte face has become a favourite pastime for me nowadays.
    One day he says SBI is flushing wiht funds. next day we raise rates.
    One day he says we do well. next day he cries his NPA’s are at 5%.
    What a man?

  • mangoman says:

    Raghuram Rajan has come with a bang.
    He refuses to join the FED party and signaled that he is going to target the inflation. While this augurs well to the long term financial health of the country, in short term some inevitable pain is bound to happen for leveraged players.
    As expected the corporate mafia is upset. The political class who thought Raghu is a pushover is shell shocked. Chidambaram did not come on TV from yesterday. Montek Singh is so shell shocked yesterday as he refused to comment on RBI policy initially only to do a volte-face later on. We will take you through a happenings around Monetary policy from Mangoman. Your only source of very honest and open and brutal truth of Indian Economics.
    Chidambaram would have thought Raghu would help him to buy time until next elections. This is especially true when Raghu said last year that RBI was having room to cut rates. My opinion is that Raghu underplayed until he gets the chair and after getting the chair he is doing what he has to do. I fully support his action. That is how we need to do it. Montek Singh who looks like a intelligent is so shocked yesterday and as usual he predicts good times for economy from here on. It should be noted that he along with C.Rangarajan predicted the bottoming out for the past 5 years which is unprecedented. Entire political class may not be happy now. But they have no other option but to wait.
    MSF and REPO
    The actual policy action is that Raghu reduced MSF rates from 10.25 to 9.5 and increased Repo rates from 7.25 to 7.5. In actual terms this is net positive for banks. Banks and Industry to be thankful for him to reduce the rates. But still they are critical of him. This is because he sounds very hawkish and raised the rates.
    The actual fact of the matter is that the MSF is primarily a liquidity instrument and banks are not supposed to borrow in that window. If a bank is doing good business they will manage their own funds and even in times of crunch Repo would help them. If Repo also exhausted then they should go to MSF which was introduced recently after Lehman collapse. But the in-efficient Indian bankers now claiming MSF as a birth right and continuously using this window for their day to day operations. This is because
    1. For most of them their loan book is nothing but a sham.
    2. A lot of money is stuck in real estate and except the retail loans all the other loans are stuck and they merely do a CDR or eve rgreening of loans. Even then they are showing huge NPA’s inspite of CDR’s.
    3. That causes them to draw money from Repo daily to the tune of 2 lakh crores until few months.
    4. Since Subbu restricted Repo they are using MSF.
    5. Instead of being happy to see reduced MSF, they are concerned.
    Pratip Chaudhuri
    A side comedy show is being enacted by SBI Chief. In my opinion is one of the chamcha’s for Finance Minister. Having broken his nose twice during previous Subbu’s regime, he is not stopping talking nonsense. Already ridiculed once by Chakraborty, he is not stopping talking about CRR. He always advocates the CRR should be abolished.
    Yesterday Raghu took a dig at him by telling that CRR issue is a peanuts compared with larger issue. Now we can take a informed decision whether IMF economist Raghu is right or Chaudhuri?
    After Raghu spoke about peanuts, Chaudhuri was furious and he shows his displeasure known by telling the MSF rate reduction is peanuts for him. What a loser?
    I have already written a few articles about this Chap. Last week he spoke about SBI flushing with funds and now he says he is gonna to raise rates. He may tell because of others increasing rates he has to. Whatever may be.
    I wonder what is his problem in raising the rates? probably he thinks that if he raises rates then the valuable borrowers like kingfisher will not borrow from him? Is that it? The dancer who does not know dancing is criticizing the stage. This is what happening in India.
    Pratip Chaudhuri is a typical example of Indian Banking System. The lazy bankers.
    Raghuram Rajan
    Now Raghu having raised Repo and has given a message to market and others that he is gonna to attack inflation. But mangoman is not ready to give full marks to Raghu even though I feel he started right. In my opinion Repo has to be raised to another 1% immediately. There are thousands of policy rates floating around in India. He has to abolish all rate and keep only Repo and CRR.
    The good thing he said is that unlike Subbu, he said he is neutral and not committing anything to corporate mafia in terms of rate cut. He links rates to inflation clearly. That is only the reason markets as well as corporates, bankers all are upset