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Money rate at 2008 high may prompt lower reserve requirement

Bloomberg  |  Mumbai 

India’s money-market rates hit a three-year high amid a worsening cash crunch, fuelling expectations that the Reserve Bank of India (RBI) will cut reserve requirements for the first time since 2009.

The rate at which banks lend overnight to one another jumped 428 basis points this year to 9.78 per cent on December 23, 128 basis points above the central bank’s benchmark rate, data compiled by Bloomberg show. That’s the widest premium since March. Similar interbank borrowing costs declined 143 basis points to 3.74 per cent in China, while they rose 24 to 10.88 per cent in Brazil and 290 to 5.58 per cent in Russia.

A record run of interest-rate increases has curbed consumption in Asia’s third-largest economy, prompting factory output to shrink 5.1 per cent in October from a year earlier, the first contraction in more than two years. Standard Chartered Plc and ICICI Securities Primary Dealership Ltd. predict the Reserve Bank of India will cut the cash reserve ratio by 50 basis points to 5.5 per cent next month.

“Now is a good time to cut the reserve ratio, which can be the first in a series of steps to spur credit growth and turn around the investment cycle,” Deepali Bhargava, Mumbai-based chief India economist at Espirito Santo Securities, a unit of Portugal’s Espirito Santo Financial Group, said in an interview on December 23. “Liquidity is extremely tight and something needs to be done about it.”

Lenders in India have borrowed from the central bank each day since April to meet fund shortages that deepened as policy makers raised interest rates seven times in 2011 to slow inflation that has stayed above 9 per cent. Such loans surged to an unprecedented Rs 1.73 trillion ($32.8 billion) on December 23, Reserve Bank data show.

The cost to lock in borrowing costs for a month using interest-rate swaps jumped 34 basis points last week to 8.92 percent, the highest level since October 2008.

Costs to protect the bonds of Indian banks against non- payment are rising at the fastest pace among Asian lenders as the worsening cash crunch threatens profits. Five-year credit- default swaps on Mumbai-based ICICI Bank Ltd., the nation’s largest private lender, jumped 71 basis points in the past month to 489 basis points, the most in the region, while those for State Bank of India rose 49 to 392, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

Similar contracts for China Development Bank fell eight to 290 and those for Korea Development Bank slipped 21 to 186. Credit swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a nation or company fail to adhere to its debt agreements.

Funding Costs
Rising money-market rates are boosting funding costs for companies, making it more difficult for them to cope with the slowest economic growth since 2009. Three-month commercial paper yields for top-rated borrowers jumped 25 basis points, or 0.25 per centage point, this month to 10.10 percent on December 23, the highest level since June, data compiled by Bloomberg show. Central bank Governor Duvvuri Subbarao signaled on December 22 that the $1.7 trillion economy may expand less than an earlier estimate of 7.6 per cent in the year through March 2012. He left the benchmark repurchase rate unchanged at 8.5 per cent on December 16, after raising it by a total 375 basis points since the start of 2010 in the fastest round of increases on record in India.

The Reserve Bank resumed open-market purchases of sovereign debt after 10 months in November to boost cash in the banking system. It has purchased Rs 331 billion of securities at auctions in the past month, official data show. The monetary authority eased rules this week for banks to access funds from it by using bonds as collateral and has increased the frequency of auctions where lenders can raise money.

‘Twin Purposes’
“The liquidity deficit is likely to persist above the RBI’s comfort level,” Nagaraj Kulkarni, a Mumbai-based fixed- income strategist at Standard Chartered said in an interview on December 23. “If concerns over growth intensify, the central bank is likely to reduce the cash reserve ratio by 50 basis points, which would serve twin purposes of softening monetary stance and directly injecting cash into the banking system.”

The People’s Bank of China cut the reserve ratio for banks by 50 basis points from December 5, the first reduction since 2008. Russia’s Bank Rossii unexpectedly cut its refinancing rate by 25 basis points to 8 percent on December 23. Brazil’s central bank has cut the Selic rate by a total 150 basis points since August to 11 per cent.

‘Demand-Led Inflation’

Policy makers in India may be reluctant to follow China’s example as the South Asian nation’s inflation remains above 9 per cent, according to FirstRand Ltd. Annual increases in the benchmark wholesale-price index averaged 9.6 percent in the first 11 months of this year, government data show.

“The Reserve Bank will be in no mood to cut the cash reserve ratio now as demand-led inflation is still there,” Krishnamurthy Harihar, treasurer in Mumbai at FirstRand, said in an interview on December. The cash crunch in India’s financial system was aggravated this month by quarterly corporate tax payments that probably led to an outflow of 690 billion rupees from banks, and the resulting tightness in the money markets may be temporary, Reserve Bank Deputy Governor Subir Gokarn said on December 21. Policy makers will take “appropriate steps” to address the cash shortage, Governor Subbarao said in the eastern city of Kolkata on December 8.

Bond Yields
Ten-year government bond yields in India climbed 45 basis points, or 0.45 percentage point, in 2011 as the Reserve Bank raised rates. The yield on the 8.79 percent note due 2021 climbed three basis points on Dec. 23 in Mumbai to 8.37 percent, according to the central bank’s trading system.

Rupee-denominated bonds returned 6.1 percent this year, compared with the 20.8 percent earned by Indonesian debt, HSBC Holdings Plc indexes show. The extra yield demanded on 10-year Indian government debt over similar-dated U.S. Treasuries was 640 basis points at the end of last week, 57 basis points below a record 697 basis points reached in November. The rupee weakened 0.4 percent to 52.9588 a dollar on Dec. 23.

“The central bank may follow up its bond purchases by cutting the reserve ratio in January to provide liquidity,” Debendra Kumar Dash, a fixed-income trader at Development Credit Bank in Mumbai, said in an interview on Dec. 23.

-With assistance from Jeanette Rodrigues in Mumbai. Editors: Anil Varma, Sandy Hendry

First Published: Mon, December 26 2011. 01:15 IST