Even as yields fell below 8% after RBI’s promise of liquidity, banks have started raising both deposit and lending rates.
Ahead of the monetary policy review meeting this week, RBI has done what the money markets have been long awaiting—it promised more liquidity. On Monday, the central bank said it would, through OMOs, pump in some Rs 36,000 crore of funds in October. Late last week, the government did its bit to help the bond markets: it said it would borrow Rs 20,000 crore less at a gross level. While the Rs 36,000 crore of OMOs will help, it is not enough for bond investors reeling under losses on the back of a steep hike in yields over the past year.
Thanks to the RBI’s intervention in the forex markets, advance tax outflows of close to Rs 1.3 lakh crore, a slight pick-up in demand from companies and some festive demand, there is a lot less money in the system than there there was last year at this time. The total repo borrowings (including term repo and MSF) of Rs 192,324 crore on September 27 was the highest since April 4. Liquidity infusion was, therefore, necessary and RBI did well to announce the calendar for a whole month rather than for single tranches. The central bank will need to continue to keep the system liquid.
Given the busy season has begun, Indranil Sengupta, economist at BofA Merrill Lynch, estimates a shortage of some Rs 50,000 crore in the December quarter even after Rs 90,000 crore of OMOs. Sengupta believes RBI would need to OMO around $40 billion (Rs 2.8 lakh crore) by March if FPI flows stay flat. Around $11.77 billion of foreign portfolio investments (FPI) have moved out of the bond and equity markets between April and September.
The problem is that, even if the government is going to borrow a little bit less in H2FY19, it has already spent 44% of its budgeted capex in the first five months of the year compared with 35.5% in the corresponding period of 2017-18. Also, with indirect tax collections not quite in line with expectations, the government is going to find it hard to stick to its 3.3% fiscal deficit target, unless there is some major pruning of expenses.
Apart from less stimulus for the economy, this would also crimp liquidity. In other words, there could be a government-led squeeze ahead. In any case, even after falling to below 8% on Monday, yields are quite high already. Moreover, with the rate of growth of deposits at just about 8-8.5% y-o-y compared with an increase in non-food credit of 11-12% y-o-y, banks have been compelled to pay savers more and have therefore upped lending rates.
Three top banks have hiked their loan rates and even if the increases have been relatively small at 5-10 bps, it will hurt borrowers. In a sense, the banks have demonstrated that, regardless of what RBI’s decision is, they need to do so. This means the cost of funds for non-banking financial companies (NBFC) will also go up.
For some time now, NBFCs have been borrowing short via commercial paper (CP) to fund their loans but that might not be possible anymore with tight liquidity. However, with about a dozen banks constrained by RBI rules, weaker NBFCs now have fewer options. In the near term, access to funding is likely to remain limited.