The monetary policy review delivered a status quo on policy rate and stance as was widely expected. That said, and despite substantial liquidity infusions undertaken even since December leading to comfortable core liquidity now, market expectation was nevertheless strong for incremental steps on liquidity. However, this was largely disappointed as there were no new steps announced even as the forward guidance on liquidity was strengthened. Thus, notably, the Governor said: “Liquidity management would be pre-emptive with sufficient allowance for unanticipated fluctuations in government balances, changes in currency in circulation, forex intervention, etc.”
Expect Everything
To tell the truth, we have been somewhat surprised lately on the extent of market’s continued expectations from RBI. This is despite the central bank over-delivering (versus expectations) on measures undertaken since December. These, and our calculation of core liquidity are summarised below:
Note, we have not considered the 90-day VRRs in the core liquidity calculation above even though they are effectively adding to the liquidity for the period they are provided for.
To be fair, there are three aspects to market’s expectation. We discuss these below and our views on them. As always, our counterpoints are made respectfully, with recognition that all views are presented with logic and sincerity; ours as well as others’:
- OMOs to cap bond yields: The observation here has been that bond yields have been stubbornly high in the face of rate cuts and therefore transmission needs to be ensured via more OMOs. This is the one we have the most disagreement with, for a variety of reasons: One, while OMOs thus far have been for the traditional reason of augmenting core liquidity, they nevertheless have amounted to almost 75% worth of net issuance of central government bonds since January last year. Thus, RBI has by far been the biggest buyer which is clearly not sustainable over the medium term. If despite this bond yields are elevated, they are reflecting other factors at play as well. These include global factors, as also observed by the Governor. For commercial demand to sustainably step in and market to become self-sustaining again, yields must reflect market dynamics. Two, continued OMOs outside of core liquidity requirements will at some juncture start veering into the approximate area of what can loosely be termed as debt monetisation. Given that we don’t print one of the reserve currencies of the world and given that we run twin deficits in a world of volatile capital flows, it is imperative that policy making continues, as it has, to prioritise macro stability. These aren’t exceptional times (like a pandemic growth shock as an example) that may require such kind of interventions. Three, as continued strong credit growth shows, it isn’t that price of money is coming in the way of growth rates.
- Further proactive liquidity infusion to ensure sustained comfortable headline liquidity: We have seen in the past that despite RBI ensuring more than adequate core liquidity, swings in government cash balances have led to large swings in headline liquidity. There is also a view that banks must keep some balance under SDF given longer banking hours, and hence the buffer on headline liquidity needs to be even higher. This seems a valid argument to us, and it also looks like RBI is taking cognizance of this. This is reflected in both the step up in liquidity operations since December as well as the emphatic forward looking assurance provided by the Governor in his statement with respect to liquidity.
- Steps to alleviate pressure on banks’ resources: Given higher credit to deposit ratios, banks are naturally facing higher resource constraints. Market was talking of expectation around bringing forward effective LCR dispensations from April to now, as well as steps like either temporary CRR cuts or counting CRR under LCR. However, these expectations have been disappointed. The Governor has mentioned seasonality on credit to deposit ratios, with the approach seeming to be that RBI is proactive on liquidity management, leaving banks to run their credit to deposit ratios. We have no strong view on this aspect, but for the observation that pressure on money market rates will probably remain for the rest of the ‘busy’ season ending in March
Takeaways
RBI has been very proactive with liquidity infusion over the past few months and continues to commit to future proactive steps as needed. With measures already taken, and with some likelihood of lower FX interventions ahead, the system seems well supplied on liquidity for the time being. Thus, even as further OMOs may very well be forthcoming, the intensity thereof is expected to reduce. This should allow yields to adjust to market clearing levels especially as we seem very much at the bottom of the cycle. While we now are probably in a reasonable period of hold on rates (Governor: expect policy rates to be low for a long time), the next discussion at whatever point may turn to how long is this hold. While we rush to caution that it is yet premature to delve here, we are also keenly watching global developments. US data surprises have spiked to the positive side (outside of employment data), and metal prices outside of precious metals have also been rising (notwithstanding very recent corrections). RBI’s own assessment on growth vs inflation seems to have shifted modestly (better growth, similar inflation), as summarised below:
While these shifts, both local and global, are very marginal (and therefore there is a risk of overreading into them), what is also true is that around potential inflexion points one must be extra vigilant. This is especially so as markets tend to jump ahead in terms of pricing a change in direction. To clarify, we are happy to assume for now that policy rates are on a long period of hold. However, we also expect market yields to respond to both changing global factors as well as the higher gross bond supply lined up locally for the financial year ahead.
More generally, we are now more ‘value sensitive’ given a somewhat ‘tougher’ global narrative and want to keep some flexibility given prospects of higher bond market volatility. As things stand, bank CD rates and front-end corporate bonds (up to 3 years) seem better poised from a valuation standpoint, even as performance here may only start to get unlocked once the ‘busy’ season is over and credit to deposit ratios ease. Government bond yields don’t appear as lucrative to us for the time being, given RBI’s heavy presence here till now. Thus, our general portfolio stance remains: 1< to be underweight duration 2>keep some cash / quasi cash for now for flexibility 3>use interest rate swaps as fit to also manage overall duration risk where applicable. However, we must again emphasize that this represents our thinking and general portfolio stance as of date and these may change going forward.
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