The RBI has announced an indicative (Open Market Operations) OMO calendar for INR 36,000 crores for the month of October. This has been done “on an assessment of the durable liquidity needs going forward and the seasonal growth in currency in circulation observed in build-up to the festive season”. This announcement is consistent with our general view that RBI is likely to be less hawkish than market expectation given the aggressive tightening in financial conditions lately (please refer “Too Tight? A Market Update”, dated 24th September for details https://www.idfcmf.com/insights/too-tight-a-market-update/ ); although the announcement of an actual calendar is a positive surprise. This measure had been preceded by dispensations given on Liquidity Coverage Ratio (LCR).
The other positive development lately has been announcement of the second half government borrowing calendar. After a INR 50,000 crores surprise cut to the full calendar when announcing the first half borrowing, the government has delivered an additional INR 20,000 crores cut to the second half calendar. Thus versus the budget announcement, the government will now borrow INR 70,000 crores lesser. Not just this, state borrowings have also been surprising on the lower side thus far. Thus states have borrowed INR 1,00,000 crores lesser than indicative calendar in the financial year so far. The Q3 calendar announced is also not particularly heavy at around INR 1,25,000 crores. Assuming this gets fully issued for a change, and accounting for a larger Q4 calendar, borrowings are looking similar to last year, especially on a net basis. If true, this is a far cry from the general concerns expressed thus far with respect to state finances.
Implications:
1. With a combination of liquidity measures taken so far, it is likely that market discounting of future rate comes off. The RBI policy at the end of the week will play an important role in this as well. Irrespective, the liquidity measures themselves have served to stabilize front end rates somewhat. Thus while ‘busy season’ effects will still be in play as credit to deposit ratio spikes, the rise in yields may now be more contained than previously thought.
2. Accounting for expected OMOs, the net supply on government bonds is only around INR 75,000 crores till March. Whereas, as described above, states have at least as yet not played spoilsport. This argues for term premia on government bonds to stabilize from here on, at least on bond supply considerations. The other input into current term premia is expectation of future repo rate. One will get further clarity on this with RBI policy at the end of the week. Our base case is of two more rate hikes till end of the year, versus three plus that market was discounting until very recently. Risk to the view, as before, is from a further appreciable rise in oil or weakness in INR.
Conclusions
The RBI moves so far have been consistent with our view that it makes sense to push against excess financial tightening in the interest of financial stability and to not unnecessarily jeopardize future growth. It continues to make sense to play this theme via quality front end assets, sovereign and AAA, in up to 5 year segment for the most part.
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