The Reserve Bank of India (RBI) on September 30 announced a 50-basis-point (bps) hike in the repo rate, stepping up its fight against persistently high inflation. With the latest rate hike, the repo rate now stands at 5.9 percent.
Repo is the rate at which the central bank lends short-term funds to banks. One bps is one-hundredth of a percentage point.
In an interview with Moneycontrol, Yes Bank’s chief economist Indranil Pan shares his views on RBI’s recent policy. Edited excerpts:
The RBI has doused concerns of a liquidity deficit and said it will improve from October. But we have seen short term yields spike in the past few weeks. Is liquidity really of concern?
The liquidity deficit is just a short term issue. The month end spending of the government for salaries, hiked Dearness Allowance (DA), etc., will bring back part of the liquidity that has moved out of the banking system on account of advance taxes and Goods and Services Tax (GST). The RBI has also said that banks can draw down the excess cash reserve ratio (CRR) and statutory liquidity ratio (SLR) to augment liquidity in the system that could be genuinely needed for credit growth.
Having said, the RBI has now merged the 14-day and the 28-day variable rate reverse repo (to a single 14-day VRRR) to provide a boost to liquidity. Finally, the expectation is that as in any other year, the central government spending will increase in H2 (second half) compared to H1, and this should provide a further boost to liquidity.
Our calculations show that the cash surplus with the central government now could be around Rs 3 trillion. However, liquidity can be a concern if the Rupee depreciation pressure sustains and the RBI has to consistently sell dollars to cool these pressures. But this too can be neutralised with the liquidity tools the RBI has at its disposal.
The five-year and 10-year yield curve inverted briefly this week. Could we see similar episodes in the future? Does the yield curve inversion indicate economic recession?
I am not sure if yield curve inversion in India gives any sense of economic recession. For instance, I clearly remember in 2013, when the RBI had raised interest rates by 300 bps in one single sledgehammer move to cool the currency depreciation pressures after the Taper Tantrum. At that point, the yield curve did invert but we did not witness any recession – no quarters emerged with negative growth.
At certain points in time, the RBI has also stepped in to manage long term yields and in those instances, the yield curve is likely to have flattened significantly. However, these are not signs of recession. Importantly, the Indian Government Securities (G-secs) bond market is still largely a domestic investor-driven market and there are also regulatory requirements for commercial banks to invest in G-secs.
The correlation between yield curve inversion and recession is stronger in freer markets of the advanced world. In the United States, an inversion of the yield curve has mostly preceded a recession.
As the RBI has refrained from giving future guidance, how much more of a rate hike do you expect going ahead?
The RBI did not give any forward guidance on the policy front and indicated that in the current highly uncertain environment, forward guidance may indeed destabilise financial markets. I totally agree. In this context, RBI has indicated that they would be nimble-footed and not be “constrained by conventional or textbook approach to policy making.’’ Taking a view on the future course of repo rate hikes is fraught with risk and equivalent to a dart game.
However, at the current juncture of how global and domestic macro conditions are evolving, I would place my bet on the RBI raising the repo rate by 35 bps in December 2022, and another 25 bps in February 2023, before pausing and evaluating the domestic growth-inflation mix and the implications of the global monetary policy cycle.
At the time of the pause, the repo rate is thus anticipated at 6.5 percent. However, in the event that inflation is on the higher side in October and November, the RBI should not hesitate to raise the repo rate by 50 bps in December.
What kind of a funding strategy should a corporate adopt in the current rate hike cycle in India?
No doubt interest rates are going up in India. In the event that any corporate has an expansion planned in the next few months, it is better to tie up the funding sources earlier than later. This is also because of the fact that the borrowing cost of the corporate will not only depend on the repo rate, but also the liquidity position of the banking system, which might lead to an increase in credit spreads.
Do note, that for eligible borrowers, external commercial borrowing (ECB) might not be an option at the moment. Global interest rates are on the rise and the Rupee depreciation will also weigh on borrowing costs if corporates want to access the ECB route. Thus, the pressure will be on the domestic credit channel – this is another reason why it might be prudent to tie up funding sources soon.
What kind of investment strategy should investors adopt, given that the short-end has become so expensive?
Currently, the overnight rate is hugging the marginal standing facility (MSF) rate, but this is unlikely to sustain for long as the liquidity position of the banking system is expected to improve. Thus investing on the basis of higher short-end rates may not be a good idea unless the liquidity of your investment product is a priority.
On the other hand, we anticipate the 10-year G-sec yield to be within 7.50-7.60 percent for the remaining part of the year, on the assumption that the government will not increase its borrowings over and above the calendared planned amounts for H2. Ten-year G-sec yields today closed at 7.43 percent, thus investing in gilt funds at this juncture may not be a bad option.
Was the policy on expected lines?
The policy was surely along expected lines as the RBI maintained its hawkish rhetoric given the 7 percent inflation in September. If we were to deduce the inflation for October, it is likely close to 7.4 percent. This justifies the 50 bps increase. The stance also indicates that there are still more rate hikes to come.The interesting part for me is that rarely does a monetary policy communication have so much to say about Rupee exchange rates. The Governor’s statement has two full paras explaining the importance of a stable exchange rate, and the adequacy of forex reserves. To me, the most important sentence is in para 24 of the Governor’s statement, where he says, “Over the medium term, the primacy of price stability embedded in our flexible inflation targeting framework provides the anchor for exchange rate stability.’’ Thus, the question is – will the interest rate policy of the RBI be focused on anchoring expectations of the exchange rate market?