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Romesh Sobti

The market has approached the monetary policy with a positive note and bullish undertone.

All markets — money market, foreign exchange, stocks and commodity — have reversed their bearish stance (post-January 2009 Policy) and exhibited signs of stability.

More important, there is liquidity over-hang in the system and the market stands reassured about the RBI’s ability to push through government borrowings without disruption in the market.

The excess liquidity has guided term rates and bond yields lower to acceptable levels. There are signals of off-shore liquidity flowing into domestic bourses and the debt market, which has guided rupee stability.

Inflation is low with stable crude oil and excessive money supply not being a risk factor.

All these positive cues have helped the RBI deviate from its main agenda of maintaining market stability (with acceptable price volatility) and focussing on the critical issue of putting the growth momentum on track.

Given that the availability of liquidity at affordable cost is there to stay in the near term (till July 2009 policy), the expectation on run-up to the policy was to hear from the RBI on its strategies to direct excess liquidity (currently over Rs 1 lakh crore) from reverse repo counter into productive sectors of the economy and measures that would address growth issues to guide FY-10 GDP growth at 6-7 per cent from FY-09 estimate of sub 6 per cent.

The unanimous expectation ahead of the policy was “no-change” stance on rates and statutory reserves with strong expectation build-up for placement of a “cap” on liquidity flows into the reverse counter to divert the excess liquidity into the system.

Given these expectations ahead of the policy, delivery of 0.25 per cent cut in policy rates for LAF corridor of 3.25-4.75 per cent is a kind of balancing act, as placement of “cap” on reverse repo may not be a prudent solution, given that the current excess liquidity is near-term in nature.

The cut in the repo rate is a facilitating nudge to the downtrend in lending rates as the RBI remains concerned about the lag between cut in policy rates and lending rates of banks.

The benefit will definitely accrue to borrowers with a downward shift in rate structure by minimum 0.25 per cent with partial benefit in the short-term bond yield curve with 1Y T-bill expected to range trade within 3.75-4 per cent and 10Y bench mark at 6.25-6.5 per cent.

This risk is that the bond rally will be arrested if there is no expectation of further rate cuts, with the best scenario of 0.25 per cent cut in July 2009, thus reducing the demand for participation in the government borrowing programme.

More Stories on : Credit Policy | CRR & Bank Rates | Economy

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