The official stance for the second half of the year has now changed to:

As you will notice, the wording of the first point in both of these is quite similar apart from the fact that "while keeping a very close watch on the movements in the price level" has been replaced by "while placing equal emphasis on price stability". The second point is also very similar. The only difference is that the earlier stance gave precedence to growth momentum over macroeconomic and price stability whereas the order of preference has changed in the current stance. Another point about a measured approach towards stabilising inflationary expectations has been added in the latest monetary policy stance.

It is quite clear that the central bank's tolerance for further jumps in inflation is very limited. If inflation continues to move north, we could see a few more hikes. A close read of the policy document gives one the impression that the RBI believes that the economic recovery does not require the crutches of monetary accommodation any more. The investment led economic upswing looks like here to stay for sometime and hence the need of the hour is to focus on and manage inflationary expectations before it assumes threatening proportions.

It has also tried to address the demand-pull side of inflation by making it more expensive for banks to give housing loans and extend other forms of retail credit. The risk weightage for capital adequacy has been increased for housing loans from 50 per cent to 75 per cent and for other forms of retail credit, from 100 per cent to 125 per cent.

The liquidity situation has worsened quite significantly in the recent period. Although a large surplus in the Government's account and the regulation currency expansion ahead of Diwali are the two prime culprits behind this tightness, the central bank is doing little to help. They have cancelled the scheduled MSS auction on November 10, but that is hardly causing any liquidity inflow.

We shall see an inflow of only Rs 250 crore on account of the 91-day T-Bill maturity under MSS and not Rs 1,500 crore that the market believes, as the central bank had accepted only that many bids in the August 13 auction. Hopefully, they will continue to cancel a few more of such auctions and the Government will end up spending some of its surplus, which will improve the overall liquidity situation going ahead.

At times I think that may be the tightness has the blessings of the central bank and it may end up staying for longer than we would like to believe. The RBI must have been aware that liquidity will tighten quite significantly if it announced State and Central Government bond issues back to back, more so around Diwali. I refuse to believe that the RBI is not aware of the ongoing investor banks' apathy towards Government bonds and hence the damaging impact of a large auction in such a tight money environment. Yields have gone up by more than 25 basis points across the curve post the auction announcement.

In spite of all this, it chose to go through with the auction at a time when the Government did not need the money. A back of the envelope calculation will tell you that the Central Government was running a surplus of Rs 21,000 crore as on October 29. So clearly, the RBI could have easily cancelled the auction or at least waited for the liquidity situation to improve. But it chose to do neither.

Although a 7 per cent plus yield for a 5.5 year paper looks extremely attractive, but given the RBI stance, I will still be wary of large long positions.

(The author is senior trader, Interest Rates at HSBC Mumbai. The views expressed herein are his own and not necessarily those of his employer.)

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