The Hindu Business Line : Giving the policy a gilt edge

THE RBI Mid-Term Review of the Annual Policy 2004-05 was eagerly awaited this time around, though such a policy announcement had almost become a non-event as the central bank had preferred to deal with the developments and taking the required action without waiting for the traditionally followed policy announcement timings twice a year in the last few years.

The market was in a guess and was even betting as to whether the Mid-Term Policy would contain any revision in the interest rates or would deal with it later on during the year. A section of the market participants however, did expect a 25 basis point hike in the repo rate (to be called as reverse repo rate hereafter) taking it to 4.75 per cent as imminent.

With this, it appears to be the end of the "softer" or the "neutral" interest rate stance taken by the RBI during a period of the last two or three years. The central bank has also given an indication that rates could be firmer in the times to come.

While doing so, the RBI has also recognised the need to align its interest rate policy stance with the market perception and international trends as reflected in the secondary market transactions and primary gilt auctions.

While the 10-year yields soared from 5.15 per cent in April this year to a peak of 6.99 per cent earlier this month and has been hovering between 6.65 per cent to 6.75 per cent even when the repo and bank rates remained unaltered at 4.5 per cent and 6.0 per cent for quite sometime.

The immediate response to the policy announcement from the bond market was that the prices of benchmark securities fell by 1.0 to 1.5 rupees, taking the 10-year yield over 6.82 per cent.

With increasing credit offtake and investment demand, coupled with an unabated upswing in inflation, on the back of an unprecedented and continued rise in oil prices, upward revisions in commodity prices and less than expected monsoons, the RBI has preferred to prioritise price stability over the growth concerns as is evident.

They have also revised the inflation expectation at the year-end from 5.0 per cent made in the May announcement to 6.5 per cent now.

A substantial part of the government borrowing programme for the second half of the fiscal still remaining and banks who are the major investors (at over 60 per cent), expected to remain on the side-lines on account of their preference to going for credit expansion and their present substantially high level of gilt holdings; the supply of government papers is likely to be far in excess of the demand. With these developments, the Indian bond market will continue to wade through further difficult times.

The primary dealers (PDs), whose main business is dealing in government securities, will indeed continue to be at the receiving end during these trying times.

The expected move by the RBI giving exclusivity to PDs in the T-Bills primary market as a part of an eventual exclusivity to PDs in the primary gilt market is yet to be realised. The policy is pragmatic and reflects a cognisance of gilt market developments, the focus now being shifted to price stability and growth coming next in priority.

(The author is Managing Director, Securities Trading Corporation of India.)