RBI googly stumps markets

Short-term rates, bond yields jump; shares dip, rupee gets breather

The Reserve Bank of India’s (RBI’s) move to tighten liquidity to prevent a further fall in the rupee spooked the equity and bond markets, as investors feared a reversal of the easy-money policy stance of the central bank.

Monday’s RBI move to cap banks’ borrowing through the daily liquidity adjustment facility (LAF) at Rs 75,000 crore and increase the marginal standing facility by 200 bps above the repo rate to 10.25 per cent delivered only a modest lift in the rupee. On the other hand, shares slumped and bond yields zoomed.

“We think the measures, in effect, constitute a shift in monetary stance from pause to tightening,” Goldman Sachs economist Tushar Poddar wrote in a note, putting the odds at one in three on a rate increase at RBI’s policy review on July 30. (RELIEF FOR RUPEE, STOCKS & BONDS GET JITTERS)

Though Finance Minister P Chidambaram and some leading bankers downplayed the impact of the RBI move, short-term rates climbed, with the overnight rate moving up to nine per cent intra-day, compared with 7.15 per cent on Monday. These, however, eased to near zero per cent as banks that rushed to raise money from LAF in the morning found few takers for those. The one-year certificate of deposit rate, however, shot up about 150 bps. Market participants expect, the overnight rate, which was hovering around the repo rate, will now move up to the marginal standing facility rate.

Since the cap on LAF borrowing will come into effect from Wednesday, banks rushed for funds from RBI, leading to record borrowing from the facility. Banks borrowed a little more than Rs 2 lakh crore from RBI on Tuesday.

The worst hit was the government bond market, which saw the yield on 10-year benchmark bonds surging as much as 54 bps to the highest since late December.

Chidambaram rejected suggestions the RBI steps were a signal to end the easy monetary policy. “These measures should not be read as a prelude to any policy rate changes,” he said in Jaipur.

Equity markets opened in the red and the Sensex lost 250 points intra-day but later recovered and remained range-bound on the finance minister’s assurance. The index fell 183 points, or 0.9 per cent from its previous close, to end the day at 19,851. The NSE Nifty lost 76 points, or 1.2 per cent from its previous close to end the day five points shy of 6,000.

The decline in the benchmark indices was led by the fall in banking stocks. The BSE Bankex declined 4.8 per cent. Among the Bankex stocks, YES Bank fell the most (9.8 per cent), followed by Canara Bank (8.6 per cent) and IndusInd Bank (7.9 per cent).

The outlook on the banking sector has turned negative in the absence of any hope of a rate-cut. Foreign brokerage Morgan Stanley has also cut exposure to the banking stocks in its portfolio. “We are cutting banks’ weight in our portfolio by 200 bps and adding to consumer staples’. We remain cautious on SOE banks and turn negative on wholesale banks,” said a Morgan Stanley report.

The RBI measures, however, helped the rupee strengthen about 60 paise against the dollar to close at 59.32 a dollar. Market participants expect the currency to stabilise around this level and any sharp depreciation is not immediately seen. “These measures will push the cost of carry of holding long dollar positions significantly higher, considering historically forex-implied yields have rarely exceeded 10 per cent. So, dollar-rupee spot could see some further stabilisation, or even some near-term strength, with potential for a move in the short term down below the 59 level,” HSBC said in a note.

Bankers, however, played down the impact of the RBI move. SBI Chairman Pratip Chaudhuri said: “These measures are temporary, to calm down volatility. I think, once the rupee stabilises, these steps should be largely rolled back.”

On the measures’ impact on interest rates, he said: “Impact on loan growth depends on how long these measures stay. Deposit rates do not have such a close correlation with the money market.”

“RBI action is towards the forex side of market and to contain the rupee’s volatility,” Bank of Baroda Chairman S S Mundra said, adding it would be too early for RBI to change policy stance.