Posts tagged LAF

Rates raised at RBI’s first mid-quarter review

RBI released its first mid-quarter review of monetary policy today and it did not surprise on any front. As expected rates have been raised and LAF corridor has been further shrunk to 100 bps.

Highlights of the mid-quarter review released on September 16, 2010

  • Repo Rate hiked by 25 bps to 6%, with immediate effect from 5.75% currently
  • Reverse repo rate hiked by 50 bps to 5% with immediate effect from  4.5% currently
  • LAF corridor has been again shrunk to 100 bps from 125 bps earlier
  • CRR has been kept unchanged at 6%
  • RBI has said that inflation appears to have been plateaued and recent policy measures have been impacting demand and inflation
  • RBI has observed that real rates must be hiked to aid bank deposit growth

Economic scenario

Economy recorded a growth rate of 8.8% during the first quarter of the current fiscal. This has been the highest quarterly growth rate since the December’2007 quarter.

  • Monsoon has been good this year and crop production is expected to be far better than last year. Good monsoon can impact the economy in two ways. On one hand, where good crop will release the pressure on food prices, on the other hand, this would put purchasing power in the hands of rural households and create demand for goods and services which might create an upward pressure on inflation. Nevertheless, good monsoon, for the current year creates good growth prospects for the economy.
  • Industrial production has been growing at a good pace in the current year till now. Barring for the month of June, when IIP grew at a meager 5.8%, the index has shown a robust performance for the year till now. Leading indicators for service sector  activity also point to a good growth
  • Inflation has been seen moderating over the last few months. Food prices’ index and primary articles’ index both have been moderating. With new series, the index is likely to show a slightly relaxed picture of inflation. But still, inflation is still above the target level of 6% for the March’2010 level and there still remain upward pressure on inflation. RBI, in its press release has observed that, inflationary pressures are still likely to remain at high levels for some months.
  • Liquidity conditions remained in surplus level for some time, but again since last week there has been a deficit and banks have been borrowing from the Repo window. As on today, banks have borrowed Rs 51,850 Cr through the LAF facility. Liquidity conditions are expected to remain in the deficit as economy enters the busy second half of the year. With credit off-take expected to pick up, banks would need more funds to conduct their business.

 

Impact of the moves

  • Since March 19, 2010, the Repo rate has been increased by 125 bps to 6%. And since May this year, SCBs have been net borrowers from RBI through its LAF Repo window. Increase in rates will increase the borrowing costs of the SCBs and impact the profitability of banks.
  • Shrinking of LAF corridor will reduce the volatility in interest rates. With volatility in interest rates, SCBs get arbitrage opportunities in the money market and LAF. With shrinking corridor, these opportunities would get reduced. This move of RBI is in line with the aim to move to a single policy rate regime consistent with international standards.
  • Earlier monetary moves have started showing impact on the moderating inflation. This move will further contain inflation and inflationary expectations which are expected to remain at an elevated level for some more months.
  • Both money markets and equity markets had already factored in the rate rise. Post the announcement, equity markets have resumed on the bullish trend and have risen from 5830 just before the policy announcement to just under 5900 by 1 pm. Benchmark 10 year yields have also risen by 5 bps after the announcement.

 

The tone of RBI’s announcement is still on cautious with respect to inflation. It has kept the doors open for further rate hike with expectation of high inflation in the coming months and good growth prospects. We can expect some more action from RBI in the next quarterly review on November 2.

Author:Praveen Bajaj

First quarterly review of monetary policy 2010-11

Highlights of the policy

RBI Governor, Dr D V Subbarao announced the first quarterly review of monetary policy today. The measures taken were quite on the expected lines (Read our article on monetary policy expectations).

  • Benchmark Repo rates hiked by 25 bps to 5.75% with immediate effect.

 

  • Benchmark Reverse Repo rates hiked by 50 bps to 4.50% with immediate effect.

 

  • The interest rate corridor between the Repo and Reverse Repo window reduced to 125 bps from 150 bps.

 

  • CRR, SLR and Bank rate kept unchanged at 6%, 25% and 6%, respectively.

 

  • Baseline inflation projection for March 2010 increased to 6% from 5.5%.

 

  • Baseline estimate for GDP growth for 2010-11 revised to 8.5% from 8%.

 

  • Bank deposit growth target of 18% maintained for FY2010-11; Bank deposit growth stood at 15.0% year-on-year as on July 2, 2010.

 

  • Bank credit growth target of 20% maintained for FY2010-11; Bank credit growth stood at 22.3% year-on-year as on July 2, 2010.

 

  • RBI to undertake mid-quarter policy reviews starting September 2010.

 

Impact of monetary policy

  • As expected, RBI has raised the policy rates. This is the fourth rate hike since March this year raising the Repo by a total of 100 bps and Reverse Repo by 125 bps. Moving differently from earlier moves, the quantum of change in the policy rates; repo and reverse repo is different (What are policy rates?). The Liquidity Adjustment Facility (LAF) corridor has been shrunk to 125 bps, a change first time since November’2008.

What this means?

Short term interest rates, particularly, interbank repo market rates hover in between the LAF corridor in order to prevent arbitrage opportunities for the banks. Because of tight liquidity conditions, short term rates have been quite volatile. This measure is aimed at containing this volatility in the rates.

  • Since end-May, banks have been borrwoing from RBI through its LAF Repo window. Out of four rate hikes since March, two were effected when there was ample liquidity in th system. But the last two have come at a time when the liquidity conditions have tightened. Thus interest cost of banks will go up. Assuming that banks will borrow about Rs 50,000 cr for the year as whole from Repo, the combined efect of the last two hikes will shave off about Rs 250 cr from banking sector’s profits.
  • What would also hurt banks’s profitability is that deposit rates have also risen. Thus lending rates, in general will go up in order to protect net interest margin (NIM).
  • Inflationary expectations have driven RBI to raise the rates. Policy stance of RBI has shifted to “to containing inflation and anchoring inflationary expectations”. RBI has noted that inflationary expectations have firmed up. Accordingly, RBI has also raised the projection for end-March 2011 to 6%. RBI has commented that it will continue to take actions to counter inflationary expectation.
  • Though RBI has not hinted at further rate hikes, but its strong concern for inflation implies that good growth prospect along with continued high inflation will in make it imperative fro RBI to increase rates.

 

Author:Praveen Bajaj

RBI raises rates again

As predicted by our analyst Rahul Sonthalia (click here to read) and myself (click here to read) in our earlier articles, RBI has raised the policy rates almost a month before the scheduled 1st quarterly review of monetary policy due at the end of July.

In an after market hour announcement today, RBI raised the repo and reverse repo rate by 25 bps each to 5.50% and 4% respectively (click here to read about repo and reverse repo rates).

Inflation

Anticipation of a rate hike got all the more eminent after the decision to raise the fuel prices and freeing up the price of petrol last week. The move was expected to raise the WPI inflation by about 90 bps. For the month of May, WPI was at 10.16%, above the 10% mark. Though food inflation has been easing, other major indices, fuel index and manufactured products inflation has been rising. RBI in the release noted “There has been some moderation in food price inflation, but the price index of food articles continues to increase. More importantly, the prices of non-food manufactured goods and fuel items have accelerated in recent months”.

Money markets

As compared to earlier rate hikes, this rate hike assumes all the more importance as money markets are facing liquidity crunch. Volumes at repo window have been high during the week, averaging about Rs 60,000 cr for the week. Call rates are also high. This would increase the cost of borrowing of the banks. As for liquidity, RBI has extended the time limit for additional liquidity support and second LAF window till July 16 to ease the liquidity conditions.

Rates of banks

However, it is expected that it would still not lead to an immediate rate hike by the banks as base rate mechanism of pricing loans is being implemented from July 1. Impact of the same on corporate borrowing will be determined only after some time. Thus as of now, corporate borrowing may not get affected.

Market reaction

Since this announcement was done after the close of all the markets, there has been no reaction of the markets. However equity markets have been in negative for most part of the week and still indices are expected to open weak on Monday. Yields on bonds increased after the fuel price announcement last week but the same retraced back most of the gains during the current week. But for the next week again, yields are expected to open strong on Monday.

Author:Praveen Bajaj

Weekly G Sec update May 29, 2010

Benchmark 7.8% 2020 bond lost considerable ground in the week due to tightening liquidity conditions arising from the 3G spectrum payment and direction of US treasuries. Yield for the said bond closed at 7.52% on Friday, up 14 bps from close of 7.38% last week.

Bonds were bearish throughout the week tracking weak US Treasuries as rise in stock markets led to a fall in demand for safe heaven assets. In India, tightening liquidity exerted pressure on bonds along with the bond auction of Rs 12,000 cr lined up for the week.

Amount of funds parked at RBI’s reverse repo window reduced this week to an average of Rs 6,332 cr this week against Rs 42,779 cr last week.

Yields rose to the extent of 7.64% on Friday, but announcements of RBI regarding additional liquidity to be provided through Second LAF facility to the extent of 0.5% of their NDTL and waiver of penalty interest on any shortfall in maintenance of SLR arising out of availment of such facility along with RBI Governor’s comments depicting not so confident recovery induced some buying back in the bonds and led to correction in yields.

Spain rating downgrade again ignited concerns of debt crisis and increased demand for safe heavens. Liquidity conditions are expected to tighten further next week and banks are expected to avail funds from RBI through Repo facility.

Author name:Praveen Bajaj