The Reserve Bank of India may have got some more ammunition to mop up excess liquidity ? the amount of special bonds it can issue to absorb rupees has been increased ? but it still faces the daunting task of managing interest rates from peaking to boost credit offtake.
Last Thursday, it got the government nod to raise the limit through market borrowing of government paper under the market stabilisation scheme (MSS), but the RBI is still concerned about bulging forex inflows that is forcing the rupee to appreciate beyond imaginable levels. The RBI intervention?through dollar sales? is also infusing rupees simultaneously, thereby increasing the pace of MSS operations to drain out the rupee glut from the system. In effect, this exercise will now make cash-surplus banks to bid at finer rates on near-term papers auctioned through MSS.
MSS, the tool for draining out excess market liquidity, should now not exceed a total payment outstanding of Rs 2 lakh crore. The earlier limit was Rs 1.5 lakh crore. With the rupee currently at 39.49 levels to the dollar and the RBI?s frequent intervention to prevent sharp appreciation of the rupee, near-term interest rates are getting pressured upwards. Hence, tackling near-term rates become the next priority.
In fact, MSS operations are increasing the yield on the near-term up to three years, while long-term rates are more or less static. Thus, we are heading towards a flattening curve.
?Continued supply of MSS at the short end is likely to put pressure on the yield. One can expect a rise of 25 to 35 bps on the one to three-year term,?? said Mohan Shenoi, treasury head at Kotak Mahindra Bank.
It appears that the rates for the moment are artificially propped up.
?The MSS will bring about an oversupply of papers and interest rates are not likely to come down in the near term,?? said Pradeep Madhav, managing director at STCI Primary Dealer.
But the increased MSS limit may not be sufficient to manage the kind of foreign capital flows (given the differential advantage adding to the inflows) that is forcing the RBI to intervene in the currency market almost daily.
The latest weekly statistical supplement of the RBI showed a massive rise in forex reserves by nearly $12 billion or Rs 43,357 crore as of the week ending September 28, which is almost equal to the new MSS limit.
Forex reserves for the week ended September 28 stood at $247.8 billion. The rupee glut in the currency market, besides the widening differential rate caused by the September 18 US Fed cut of 50bps to 4.75% that is attracting foreign currency, remain a major concern for the RBI and domestic bankers as well.
Another point of debate is whether or not the time is ripe for the RBI to lower the repo and reverse repo rates and make the flight of foreign inflows less attractive by cutting out arbitrage opportunities.
Given the current situation, bankers feel the excess liquidity could only add to inflation that is under an upward pressure. A section of the market feels that inflation levels could zoom to 6 % in about two months and this could push up interest rates across the board.
This development, they say, would make the RBI come out with another sterilisation drive probably through cash reserve ratio hikes.
CRR, the cash that banks maintain with the RBI as a percentage over its net deposits, is currently at 7%.
?Gone are the days of a 25 basis point cut. Today even a 50 bps cut is too small given the current liquidity that is bulging by the hour,?? said a treasury head at a private bank.
Bankers said that since MSS is a long-drawn procedure, an immediate tool to have the desired impact is to sterilise the rupee through a CRR hike, which at one go could suck out Rs 16,000 crore to Rs 17,000 crore from the system.
But bankers also pointed out that long-term rates of 10 years are, however, seen range-bound, between 7.5% and 8.1%.
The MSS will not have a direct impact on bank lending rates nor the prime lending rates but they would test the waters with a reduction on floating retail loans.
In a bid to give a fillip to consumer spending, bankers said they are gearing up for a cut in select loans.
Rates on select loans like housing, car and personal loans, depending upon the cost of funding them, therefore, are likely to be lowered and tested before banks actually come out with a cut in prime lending rates.
Even though real-estate prices drive much more than interest rates, banks are cutting down home loan rates and passing on the reduced funding costs to consumers, at least for the time being.
?With the onset of festive season, we are coming out with select retail loans that will be lower from current levels,?? said B Sambamurthy, chairman and managing director at Corporation Bank.
Central Bank of India and Canara Bank last Wednesday reduced home loan interest rates by 50 basis points to 10.75% and 11% respectively.
Recently, Housing Development and Finance Corporation (HDFC) cut home loan rates by 50 basis points, as part of its festive offer for this month to 10.5%. Dena Bank is the latest to join the bandwagon with a 50 bps reduction on home loans.
