Vijay Kumar Gaba

After hearing the finance minister (and Hindi translations of what she says by her Deputy) many times in past 7 months on the issue of stimulus for economic recovery, most market participants now appear disinclined to hear her anymore. I actually found many market participants wishing that the government actually does nothing and lest the economy recover on its own.

When the RBI governor comes out to brief media about the outcome of last Monetary Policy Committee’s (MPC) meet of the current financial year at 11:45Am today, most market participants shall be praying for a very “brief statement” and “No Action” by RBI. Not many would be expecting any further easing from the RBI, given the facts that—

(i)    Food inflation has remained rather sticky and non-food inflation has also started to rear its head higher;

(ii)   Liquidity in the system has surpassed the comfort level, leading to unsustainable fall in short term rates; and

(iii)  the real rate have now turned negative and are threatening to inflate a bubble in asset prices;

The questions before RBI/MPC therefore would be—

(a)   Maintain status quo;

(b)   Change the presently accommodative policy stance to neutral but refrain from doing anything; or

(c)    Change the policy stance and tighten the liquidity through market operations (Fx sale, short term bond sale etc) and/or policy action (CRR, SLR, MSF etc.).

Besides, one of the factors in the dismal export performance over past many months is out performance of INR over other emerging market peers. RBI might have to change its stable INR policy also sooner than later.

The market participants would obviously like to hear a “status quo” decision. Anything else may dampen the animal spirits driving the markets. Also, the market participants would not like the governor to speak for long (Governor Das is known for making long statements). The fear is that is speaks long, he will leave more material for (mis)interpretation.

A recent article published in Bloomberg Quint, summarized the present money market situation and quoted some money market participants as follows:

“The Reserve Bank of India may have cause to review its ultra-easy liquidity policy when it meets this week, as short-term corporate and government borrowing rates have remained below its policy benchmark rates for an extended period.

Yields on commercial paper have traded not only below the policy repo rate, the rate at which the RBI lends overnight funds to banks, but also below the reverse repo at which banks park funds with the central bank.”

“If this (surplus liquidity situation) continues, it would lead to a persistent mispricing in the commercial paper market as the existing yields are becoming unsustainable for investors. Even the policy rates are losing relevance due to the abundant liquidity scenario. So, there needs to be an immediate intervention from the RBI.” (Rajeev Radhakrishnan, Head - Fixed Income, SBI Mutual Fund)

“A quarter of the 274 companies that tapped the commercial paper market for borrowing funds via short-term bonds, with maturity below or equal to 90 days, raised funds below the reverse repo rate of 3.35% in November.”

“The mutual funds do not have access to interbank rates, as they cannot park their liquidity with the RBI in the reverse repo market like banks can, they don’t have a choice but to keep on buying these short-term commercial papers. Because of this, the rates have compressed so much that investors are buying CPs even below the RBI’s reverse repo rate.” (Parag Kothari, Associate Director, Trust Capital)

My personal view on RBI policy stance is that RBI may continue to take a pragmatic approach and change its policy stance to neutral and let INR weaken over next few months.

The excess liquidity may have already started to inflate financial asset prices beyond sustainable levels. If left unchecked, this would result in inflation of bubbles that invariably cause avoidable pain when they eventually burst.

The policy rates are already at level that is supportive of growth. Any further broader easing may not be warranted at this stage when the investment & consumption demand growth is not accelerating. Some targeted easing may however be considered to promote investment and exports in specific areas.

The fears of 2008-09 like market freeze shall materially abate in next few months and RBI may not need to augment the Fx reserve any further. It may actually consider selling some reserve accumulated over past 6 months to fund growth and higher borrowing needs of the government.