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Fixed Income

RBI Will Remain the Lender of First Resort

RBI has promised liquidity to the system:

Beginning with the Mid-Quarter Review of September 2013, the Reserve Bank of India began a calibrated unwinding of the exceptional measures undertaken since July so as to restore normalcy to financial flows. Currently, the Reserve Bank is injecting about Rs 1.5 trillion into the system on a daily basis through the liquidity adjustment facility (LAF), the export credit refinance facility (ECR) and the marginal standing facility (MSF) taken together. Nevertheless, liquidity conditions have been tightening as reflected in the hardening of yields in the government securities market due to uncertainties around the Government borrowing programme for the second half of 2013-14 as well as the prospective effects of banks’ half-yearly account closure, the seasonal pick-up in credit demand, festival-related demand for currency and sluggish deposit growth. The Reserve Bank is closely and continuously monitoring liquidity conditions and will take actions as appropriate, including open market operations, to ensure that adequate liquidity is available to support the flow of credit to productive sectors of the economy.

Great.

With Marginal Standing Facility (MSF) borrowing the biggest part of the system, things have been rather tight:

  • MSF around 60-80K cr (600 to 800 billion) rupees.
  • Repo around 40K cr. rupees
  • Credit refinance facility between 30-40K cr. rupees.

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The 10 year bond has gone to 8.8% after being at 8.15% on Friday morning; in just four days, yields have tightened.

The MSF rate is the operational rate, so it’s at 9.50% right now. This is now flattened out the yield curve, where you have short term rates around 9.5% (Call, CBLO, MSF) and longer term rates are around 9%.

Liquidity easing through OMOs is going to happen, but I hope they allow for much higher yields. If we want a normal yield curve, long term rates deserve to be 10% or more. That would definitely be good for bringing down inflation.

A note for the RBI: Why are you worried about liquidity, when banks haven’t yet cashed in the most important part of the “transmission” policy of the system – that is, higher deposit rates? Most banks haven’t raised these rates too much. If we could see a 9.5% rate on a 15 day deposit I’m sure most people will move their cash over. RBI should be a lender of last resort, but its turning out to be the first thing banks are running to. 

I am invested in ultra short term funds and continuing to stay there. Liquidity will get more tight as we move ahead, even if the RBI acts, and we aren’t yet seeing the impact of defaults in the system.

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