By Manish M. Suvarna
Yields on debt instruments will not be impacted, but short-term rates could move up marginally. Liquidity absorption is already happening via Variable Rate Reverse repo (VRRR) auction instead of overnight fixed-rate auction, hence the statement is contrary to what is already happening, says Sandeep Yadav, head of fixed income of DSP Mutual Fund, in an interview with Manish M. Suvarna. Excerpts:
How do you see the impact on rates of debt instruments after RBI increased the 14-day VRRR auction amount in December and announced that from January onwards liquidity absorption will be undertaken mainly through the auction route?
The impact is a bit uncertain largely because there is uncertainty understanding RBI’s intent. Already majority of liquidity absorption is occurring via auction route rather than overnight fixed-rate auction. The RBI’s statement per se does not seem contrary to what is already occurring. Our base case scenario is that there will not be a significant impact on the rates of debt instruments, though short tenor rates could move marginally higher.
We believe increased VRRR amount partly coincides with expected government spending which will increase banking liquidity. If that be the case then extra liquidity that will come to the system should be absorbed via VRRR auctions, but we do not see disruptive movement on debt instruments yields.
Do you think the higher VRRR amount announced by RBI in policy will be subscribed fully and if not RBI will make other plans to shift banks interest to the auction route from January?
If the banking liquidity does not increase significantly more, then there is a good enough chance that VRRR will not get subscribed fully because overnight liquidity is something which banks will intent to keep based on their necessity and only the residual will go in the VRRR auctions. In that case, if liquidity remains where it is, then it is unlikely that VRRR will be subscribed fully.
But, if the liquidity does increase by the end of this month (December) or maybe in January due to government spending, then yes, we will see a significant absorption in VRRR.
Even if it is not fully subscribed, I am not sure RBI wants banks to shift overnight significantly to the auction route. The higher VRRR amount would help absorb inflow of liquidity through government spending, whenever it occurs. If RBI’s intent is to move overnight amount significantly to the auction route, then they could bring up shorter tenor VRRR, because that gives banks more visibility of their liquidity.
RBI Governor in policy statement said in Q4FY22 inflation will peak, but on the other hand, it said the reduction in taxes will bring about a durable reduction in inflation, what are your views on these points?
It may seem that both statements are paradoxical, but they are not because when RBI mentions Q4FY22 inflation will peak, they refer to year-on-year inflation, but when they mention that cut in taxes will lead to a reduction in inflation, it refers to quarter-on-quarter inflation.
This kind of scenario occurs quite often because on one hand, you are comparing an annual change in index and on the other hand, the quarterly change in index. Lowering Q4FY22 projection (from 5.8% to 5.7%) itself implies that the tax cut is being taken care of in annual inflation.
Can we expect a rise in yields on G-Sec if as per RBI inflation is expected to peak in Q4FY22?
Markets are quite efficient, so RBI expects inflation at 5.7% and if it comes at this range then yields have already priced it, but if it breaches significantly above 5.7% print then yields could rise.
What are your views on the rupee as it has suffered losses in the past few days on Omicron fear?
Omicron fear has led to risk-off in global markets. Fed taper is going to be at a higher pace than what markets were expecting a couple of months back. We have seen large trade deficit numbers for the last few consecutive months. So multiple factors are affecting the dollar/rupee right now. The dollar index is also seen strengthening. For all these reasons rupee has suffered losses.
The losses in rupee is probably not a concern right now as it is not a panic spike, yet. This seems within the RBI threshold. Also, RBI has a better foreign currency reserves than what it had in previous times when rupee depreciated alarmingly.