Steady As She Goes

Both the reductions do little but to feed the rapacious bond market

Sanjay Bhasin

CEO, JM Morgan Stanley Fixed Income Securities Pvt Ltd

The Reserve Bank of India (RBI) governor Dr Bimal Jalan gave the market a palliative of a 25 basis points cut in both the bank rate the cash reserve ratio rate.

In itself both these reductions do little but to feed the rapacious bond market. On the other hand, the bank rate cut reduces the spread between the bank rate and the overnight repo rate. These marginal cuts are unlikely to impact the structure of interest rates in the economy or bring down lending rates in a big manner. Though the current spike in the weekly inflation figures is being termed as a blip, it must have certainly moderated any thoughts of a more aggressive decrease.

 

There has been a fair emphasis on cautioning market participants against expecting a uni-directional market to rule perennially, both on interest rates and on foreign exchange. Banks would do well to heed these words and build up the Investment fluctuation reserve. Similarly, corporates who have been borrowing aggressively and shortening the duration of their borrowings need to build safeguards against a market reversal.

The fact that credit spreads have narrowed along with falling rates points to a corresponding widening during a reversal. The large unhedged foreign currency exposures have also been a cause for concern. A highly leveraged mix of short term borrowings and forex exposures can make a lethal combination.

Even highly liquid trading pairs like dollar and the euro have seen sharp volatility, a comparatively thinly traded currency like the rupee can behave precariously in times of stress.

In terms of market development - vanilla interest rate derivatives will be allowed, initially to trade over the counter. This along with the recent launching of exchange traded derivatives should provide depth to the derivatives market and strengthen the interest rate market over the next few months.

Allowing banks to issue non-subordinated long term debt should elongate the non-statutory liquidity ratio yield curve to beyond the current 5 years.