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S. Balakrishnan

THE Government and RBI officials met on Monday to discuss the issue of Market Stabilisation Bonds (will it stabilise or destabilise markets has to be seen) to impound excess liquidity, which, by the way, is the RBI's own creation, stemming from its unrelenting forex intervention to support a falling dollar.

The mop-up exercise is capped at Rs 60,000 crore in the next year - on average Rs 5,000 crore per month. With the daily RBI repo auctions attracting about Rs 40,000 crore, it does seem the MSF (market stabilisation fund) bonds will not impact system liquidity all that much, although the market could become volatile at times depending upon the frequency and amounts raised in individual tranches.

Bonds have been treading water for most of the past weeks, driven by the negative inflation news and the RBI's tight grip on market sentiment. Few players now believe that there is much of a chance of a fall in the yields on G-Secs in the near future. The most pessimistic forecasts put 10-year yields at as high as 5.6 per cent towards the fiscal year end.

The MSF exercise is, of course, driven by the fear that the surplus liquidity will spill over into inflation, which remains a worry at 6 per cent levels, despite repeated reassurances from authorities that it will ease to 4-4.5 per cent soon. Our preferred inflation index for monetary policy purposes appears to be the Wholesale Price Index (WPI) measured on a point-to-point basis. On the other hand, the Consumer Price Index (CPI) at less than 4 per cent is better behaved and lower than the WPI.

In the US, the Federal Reserve attaches a lot of weight to the personal consumption index (GDP) deflator as a more reliable inflation indicator than the CPI. Some such exercise is necessary in India to get as accurate a fix as possible on inflation, given that our central bank's entire monetary and interest rate stance is being dictated by this one number and we are still far from having an inflation target.

The post-MSF meeting statement says that the bonds will be issued at market-related rates of interest. The interesting thing is that the money from MSF bonds will be completely sterilised, i.e., not available to Government. However, the Government has kindly agreed to bear the interest on the bonds, which, at current coupons, will easily work out to about Rs 3,000 crore annually and translates into a bigger hole in the fiscal pocket. The price to be paid for preventing inflation resurgence? No one can be sure at this time.

The policy dilemma on interest rates continues. Thanks to (real or imaginary) inflation fears, rupee-dollar interest differentials are too high and the MSF bonds will do nothing to chase away (in fact may increase) "hot" money coming in with full convertibility rights.

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