How Does One Read the Credit Policy Review
Whew, RBI Policy Review is behind us. Though there was an unpleasant surprise of 75 bps CRR hike (against market expectation of 50 bps) & there was knee jerk reaction in the equity markets (corrected by more than 300 points post the announcement before settling down & currently (2:20 PM) only 13 points down on the SENSEX), debt markets showed more restraint. 10 year 6.90%, 2019 went up marginally to 7.73% (pre policy levels of 7.69%), it has settled back at around the same levels. Also, against market expectations of short end of the yield curve going up, there has been only marginal move of 2-3 bps in this segment of the curve. 3 year paper of PFC which was traded at 7.48/50 % levels pre policy has marginally moved upto 7.50/52% & 5 year PFC has moved up marginally from 8.28/30% levels to 8.30/32% levels.
Though short and medium term rates have not moved up today, the same will start inching up closer to dates of CRR hikes in February. Same will be the case when advance tax outflows kick in during March 2010. This is the time when yield curve will start to flatten from its current steepness (when 1-5 year yields will start moving up). Long end of the curve is (as expected) not likely to be impacted so much.
What were the key announcements & Forecasts?:
- Reverse REPO unchanged at 3.25%
- REPO Rate unchanged at 4.75%
- CRR hike of 75 bps taking CRR to 5.75%
- CRR to suck out excess liquidity to the tune of Rs.36,000 crs in two tranches viz.50 bps by February 13 & 25 bps by February 27
- GDP growth forecast upped from 6% to 7.50% for FY 2010
- Inflation forecast for March upped to 8.50%
- Credit Growth forecast lowered from 18 to 16%
How does one read into RBI’s move of increasing CRR by 75 bps & not touching the benchmark rates?
- 75 bps or rather extra 25 bps extra CRR hike is not a cause of concern as 50 bps hike was already priced in
- RBI is expecting FOREX flows to continue & hence is expecting their intervention to stabilize $/Rs; which in turn will infuse further liquidity in the system. This additional 25 bps hike might be as a preemptive measure to counter this unabetted liquidity flows
- Systemic liquidity is almost to the tune of Rs.80,000 crs, add to this bank funds parked with MFs in liquid schemes ,add to that surplus in Government account (which is not spent so far- almost to the tune of Rs.50-60,000 crs) add to that FOREX flows. Hence, markets would still be in a comfortable liquidity situation inspite of Rs.36,000 crs getting sucked out due to CRR hike
- As & when Govt spends that surplus funds in their account on various projects, it will enhance liquidity to that extent
- As Fiscal Policy measures(like reduction in Service Tax, Excise Duty cuts, etc announced while announcing Fiscal Stimulus to prop the ailing economy) needed to be complemented with Monetary Policy measures (cut in CRR, Cut in Policy rates, etc); in the same way current reversal of monetary policy measures like hike in CRR will need to be complemented with reversal of Fiscal Measures like hike in taxes, excise duty, etc to achieve the targeted growth of 7.50% & bring down the high Fiscal Deficit numbers of the current year from 6.80% to 5.50-5.75% levels next year
- Though RBI has given some importance to curtailing rising inflation numbers; they still wish to have a sustained growth numbers to achieve the targeted GDP numbers. Growth cycle is still in its nascent stage. It needs to be accelerated
- This will surely weigh on the mind of RBI before tinkering with Benchmark rates in the near future. This might be positive for the debt markets
- Inflation forecast for March 2010 at 8.50% is partly due to food inflation & manufacturing inflation & partly projected on the higher side due to lower base impact of last year. By second quarter of FY 2010, the same is supposed to come down to the comfort zone of RBI, again due to base effect kicking in that time
What are the milestones post this Policy Review which can affect the debt markets?:
- More than the policy rates or CRR hike, the most important announcement from debt market point of view will be the borrowing calendar that will be announced on February 26’2010 Budget
- Gross borrowing of Rs.4.50 lac crs is already discounted or priced in. Any number lower than that for following reasons might be viewed positively by the markets:
- Fiscal Stimulus roll back like increase in service tax, excise duty hike etc though will be viewed negatively by the equity markets; it will be a positive for the debt markets as that much higher collections will be reported reducing Fiscal Deficit numbers
- Higher GDP growth forecast of 7.50% from 6% will be a big booster for debt markets as revenue collections should improve in such a scenario
- Also, Govt’s thrust on disinvestment of PSU stocks (which was reiterated by the FM yesterday) alongwith 3G auction numbers should have positive impact on Fiscal numbers
- Hopefully, fertilizer & oil subsidy numbers for next year should be on the lower side
- Credit pick up forecast have been lowered by RBI from 18% to 16% & hence, based on that liquidity should not be at a premium in the near future
- Lean credit season should kick in post March 2010
Hence, I see this Policy as a sigh of relief as immediate negative news is behind us (without impacting markets too much). Also this should give some insight into the mind of RBI (wherein they wish to see accelerated growth) & hence may not be in a real hurry to increase rates.
Impact of this liquidity tightness during February (when CRR hike takes effect) & advance tax outflows happen in March 2010, will be reflected in Short Term Plans for a short period of time. This asset class will have some negative impact before bouncing back post March 2010. On the other hand, if fiscal numbers for next year are on the positive side (with an assumption that RBI might not raise rates in hurry to achieve accelerated growth), long end of the curve should start rallying post March 2010. Another factor which can impact the long end positively is that Govt has almost finished their borrowing programme for the current year.
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