Cumulative repo rate hike of 75 bps expected in current cycle: SBI Ecowrap

State Bank of India’s economic research department (ERD) expects a 25 basis point (bps) repo rate hike each in June and August, with a cumulative hike of 75 basis points in the current cycle and the possibility of the Government Securities (G-Secs) yields touching 7.75 per cent by September.

The repo rate (the interest rate at which Banks borrow funds from the Reserve Bank of India to overcome short-term liquidity mismatches) currently is at 4 per cent. One basis point is equal to 0.01 per cent.

Referring to retail inflation surging to 6.95 per cent on yearly basis in March 2022 compared to 6.07 per cent in February mainly on food price inflation, the ERD, in a report, said inflation prints are now likely to stay higher than 7 per cent till September.

“Beyond September, inflation prints could hover in between 6.5 per cent-7 per cent. Our FY23 inflation forecast is now closer to 6.5 per cent, taking into account the possibility of an extended food price shock,” as per ERD’s assessment.

Per ERD’s Ecowrap report, historically, at the lowest end of spectrum, the spread between the Repo and G-sec hovers around 250 basis points (bps). In an interest rate hardening cycle, the spread vaults up to 350 bps.

“10-year Benchmark yield should thus move towards 7.50 per cent, even with the current repo rate at 4 per cent.

“Given that the spread between G-sec yields and repo rate jumps in an increasing interest rate cycle, G-sec yields could touch 7.75 per cent by September,” said Soumya Kanti Ghosh, Group Chief Economic Adviser, SBI.

Yield of the 10-year G-Sec rose about 2 basis points on Wednesday to close at 7.2148 per cent (previous close: 7.1918 per cent). Price of this paper declined 15 paise to close at ₹95.32 (₹95.47).

The ERD team believes that RBI will keep the G-sec yields capped at 7.5 per cent through unconventional policy measures.

The report noted that the current jump in yields also has to do with the RBI circular on Friday.

In principle, in order to make the Standing Deposit Facility (SDF) attractive and to bring it on par with Reverse Repo facility as far as maintenance of SLR (statutory liquidity ratio) is concerned, RBI has made deposits parked under SDF an eligible asset.

Thus, from Banks’ point of view, SDF facility offers higher return without compromising on maintenance of statutory ratio and risk exposure being minimal (counterparty being the central bank).

“As the funds parked under SDF are eligible to be reckoned for SLR, we do not envisage introduction of this facility to lead to any incremental demand for SLR securities.

“This could mean yields in uncharted territory if the RBI does not cap it. As expected, technically speaking a move to 7.5 per cent and beyond for G-sec yields could be swift and rapid as being witnessed right now,” Ghosh said.

Rising rates: effects on eco can be destabilising

The report underscored that the recent spike in benchmark yields lays bare the growing disconnect, and divergence between benchmark yields and bank lending rates, with banks entering a new territory where lending rates are now effectively lower than yields, thereby taking the sheen off risky lending.

Also, as and when benchmark rates start rising, the effective yield may spike further, a disincentive ensuring demand de-growth from corporates for proposed capex (capital expenditure).

“As banks would be forced to enhance the lending rates, aligning it with market determined course (with NBFCs following suit with a mark-up), the effects on economy can be destabilising,.

“The good thing is that we have also seen substantial increase in new investment announcements which were around Rs 10 lakh crore in last two years, increasing to a record high of around Rs 19 lakh crore in FY22,” Ghosh said.

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