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The Mid-Quarter Policy Review of the RBI has been as per expectations in terms of rate action as well as on the approach to future rate action. The market participants had a fairly high degree of consensus on the expectations from the Review: 25 bps hike in repo and reverse repo.
The question now is, how many more rate hikes to expect? The one-year overnight indexed swap (OIS) is at 7.38 per cent. Taking the repo rate as the operational rate (as against the reverse repo rate), which is at 6.75 per cent after the hike, it translates into a market expectation of approx (7.38 per cent - 6.75 per cent=) 50 to 75 bps hike over the next one year. The RBI has left the door open by stating that it will persist with the anti-inflationary stance.
‘Risks to growth'
On balance, this Review is neither aggressive nor defensive. While the RBI maintains the anti-inflationary stance, there are talks about “risks to growth”, which implies that inflation control cannot be the only objective — it has to be done in conjunction with maintaining a reasonable growth rate. One noticeable point in this Review is the re-iteration of the system liquidity target of +/- 1 per cent of NDTL.
liquidity ISSUE
Today, due to advance tax outflows, the system liquidity shortage is 2 per cent to 3 per cent of NDTL or, in other words, way beyond RBI's comfort zone. The re-iteration would give confidence to market participants on liquidity coming back to +/- 1 per cent of NDTL.
On system liquidity, the measures (for example, continuation of second LAF window and SLR leeway) are conspicuous by their absence and it shows the RBI's comfort about system liquidity normalising April onwards.
The persistent liquidity shortage in the system has pushed up money market yields and corporate bond yields.
Since March 19, 2010, when the RBI began the current rate hike (or rate normalisation cycle), one-year Bank CD has moved up by approx 3.5 per cent and one-year CP yield has moved up by approx 3.8 per cent.
This up-tick is much higher than the 200 bps hike in repo rate from March 19, 2010 till date, which has been achieved by the tight liquidity in the banking system and pushing the reference rate from reverse repo to repo.
(The author is Sr. Vice-President – Advisory Desk – Fixed Income BNP Paribas Wealth Management)
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