RBI’s September 2013 Monetary Policy Review

This post is written by Shiv Kukreja, who is a Certified Financial Planner and runs a financial planning firm, Ojas Capital in Delhi/NCR. He can be reached at skukreja@investitude.co.in

What the Finance Minister P Chidambaram must have advised the RBI’s ex-Governor D Subbarao not to do and what he must have wanted US Federal Reserve Chairman Ben Bernanke not to do, the former Chief Economic Advisor, Raghuram Rajan has done exactly that in his first ever monetary policy as the new Governor of the Reserve Bank of India.

In the RBI’s September monetary policy today, Dr. Rajan has increased the Repo Rate, which Dr. Subbarao could have done a couple of months back, and spooked the Indian markets by his actions, which Mr. Bernanke could have done a couple of days back.

Actually, Dr. Subbarao resisted tinkering with the key policy rates in July, as he wanted the markets to initially believe that his policy actions were temporary in nature and he would reverse those measures quickly, as and when there is some stability in the currency markets. But, nobody could stop the market participants to panic at that point in time and the rupee to fall from 58-59 against the dollar to 68-69 in less than a month’s time.

Just before Dr. Rajan took charge at the Mint Street, markets were in a state of disarray. There were a number of pressure points, which were taking the global markets down and making the analysts predict NSE Nifty to touch 4,800. Those pressure points included a possible US attack on Syria over Syria’s use of chemical weapons, a high possibility of QE3 tapering by the US Federal Reserve, India’s trade deficit to remain high due to low exports & high imports, Indian rupee touching a psychological 70 mark and so on.

Call it a perfect luck or whatever, since then the global markets have seen all these fears receding very smoothly one by one. Tensions over Syria have come down considerably, India’s trade deficit has gone down to $10.9 billion in August, the rupee has recovered to below 62 levels and most importantly, US Fed has postponed its tapering programme till the time it sees the US economy growing the way they want it to grow.

Today was Dr. Rajan’s first serious test as the new Governor of the RBI. So, let us check what exactly Dr. Rajan has done in his first monetary policy and what exactly he wants to do with those measures.

0.25% hike in the Repo Rate to 7.50% – RBI has increased the Repo Rate by 25 basis points from 7.25% to 7.50%. This is the rate at which the commercial banks borrow money from the RBI for a short period of time. RBI has increased this rate to discourage banks to borrow and further lend money in the market, as the dangers of the inflation moving up have increased dramatically with a steep fall in the value of rupee since its last monetary policy.

So, what actually made him raise the Repo Rate? The answer is rising overall inflation, due to steep fall in rupee and upsurge in food inflation (including onions).

0.75% reduction in the MSF Rate to 9.50% – RBI has reduced the Marginal Standing Facility (MSF) Rate by 75 basis points from 10.25% to 9.50%. This is the rate which the RBI charges to the scheduled commercial banks for the money borrowed for their overnight liquidity requirements.

If you had made any investment in gilt funds or income funds during April-June period, then you must remember RBI’s first move in July to curb speculation in the currency market. RBI had hiked the MSF Rate very steeply by 200 basis points from 8.25% to 10.25%.

Now, the RBI has cut this rate to give some relief to the banking system for which the cost of borrowing money under this window had increased considerably. Also, RBI has been able to reduce this rate as the dangers of the currency volatility have reduced in the recent few days.

0.25% hike in the Reverse Repo Rate to 6.50% – RBI has increased the Reverse Repo Rate by 25 basis points from 6.25% to 6.50%. This is the rate at which the banks deposit their excess money with the RBI for a short period of time. This rate is linked to the Repo Rate and remains 1% below the Repo Rate. These are not the times of abundant liquidity in the banking system, so there is not much significance of hiking this rate.

Minimum daily cash reserve requirement reduced to 95% of deposits from 99% – This is the RBI’s second measure in favour of improving the sentiment in the banking system. In its second big move on July 23, RBI hiked the minimum cash reserve ratio (CRR) requirement of banks from 70% of their deposits to 99%. Today, Dr. Rajan reduced this requirement from 99% to 95%. This move is going to provide some elbow room to the banks as far as the liquidity is concerned.

No change in Cash Reserve Ratio (CRR) – RBI has left the CRR unchanged at 4%. Despite SBI Chairman, Mr. Pratip Chaudhuri, asking the RBI to cut the CRR many a times in the past, Dr. Rajan also did not bulge and decided to continue walking the same path as used by his predecessor.

Impact of the Monetary Policy

What happened today here in India was the exactly opposite of what happened in the US on Wednesday. Most of the people had expected the US Fed to announce some sort of QE3 tapering, be it of a smaller quantum, but Fed’s decision to leave it unchanged left the market participants pleasantly surprised.

Today, most of the people had expected the RBI Governor to start it from where the Fed had left it that day. Markets had expected Dr. Rajan to remain dovish and reverse most of the harsh steps the earlier Governor had taken. But, people were left extremely disappointed to have a hike in the Repo Rate and a token relief on the liquidity front.

Impact on Stock Markets: After yesterday’s big upmove and immediately after the RBI’s announcements, BSE Sensex and NSE Nifty nosedived to reverse all of their yesterday’s gains and thereafter recovered somewhat to close at 20,264 and 6,012 respectively.

Impact on Debt Markets: 10-year benchmark 7.16% G-Sec yield closed at 8.58%, 39 basis points higher than Thursday’s close of 8.19%.

Impact on Currency: Though a hike in the Repo Rate should have boosted the value of Indian rupee, but a fall in both the equity market as well as the debt market resulted in rupee closing at 62.24 vs. yesterday’s 61.77, a rise of 47 paise in the value of one dollar.

So, after RBI’s policy decisions and market closing, this is where we stand as of today:

It is such a pity that even after such a wonderful Rabi season early this year and some excellent monsoon rains in most parts of the country in the last few months, we are still struggling with a double digit food inflation. The government, which is not able to manage the supply of onions in some of the major cities of India, makes big claims to ensure food security in the remote parts of the country.

The steps Dr. Rajan has taken today, I think any sensible RBI Governor would have taken the same steps, including Dr. Subbarao. Till a few days back, Dr. Rajan’s press conferences used to reflect what the Finance Ministry’s priorities were. But, the erstwhile Chief Economic Advisor is now the Governor of the Reserve Bank of India and I think his responsibilities are his priorities now. That is what got reflected in the RBI’s monetary policy today.

I think Dr. Rajan has taken a balanced decision by increasing the Repo Rate to tame inflation and by reducing the MSF Rate to cut short-term funding costs in the banking system. After today’s 75 basis points reduction in the MSF Rate, the differential between the Repo Rate and the MSF Rate stands at 200 basis points now. I think Dr. Rajan would like to take it down to 100 basis points again, by the end of November 2013. How, what & when he does it, it will depend on the domestic as well as some of the global factors. Will he succeed in his efforts or not? As always, only time will tell. But, as an Indian, I hope he does!

15 thoughts on “RBI’s September 2013 Monetary Policy Review”

  1. What effect it will have on existing investors who have invested in Liquid mutual fund debt schemes?Do you think the investors in Liquid Debt Mutual Funds may benefit from this?
    Thanks in advance for your valuable clarification.

    1. It will have a positive effect on all of the open ended debt mutual fund schemes including liquid funds, ultra short-term funds, short-term funds & gilt/income funds.

  2. RBI has just cut MSF Rate by 50 basis points (or 0.50%) to 9% to cut liquidity crunch in the banking system. This is going to help banks in reducing their cost of overnight (very short-term) borrowings and also in normalization of the yield curve. Bond markets should cheer this news to some extent tomorrow.

  3. Shiv
    You have not answered the question-“What is the rationale behind lowering MSF rates and raising repo rates”.Can you please clarify?

    1. Hi Mr. Ramamurthy,

      I have mentioned it in the first line of the last para of my post. I have done the same above in the post also.
      “RBI has increased this rate to discourage banks to borrow and further lend money in the market, as the dangers of the inflation moving up have increased dramatically with a steep fall in the value of rupee since its last monetary policy”.
      “Now, the RBI has cut this rate to give some relief to the banking system for which the cost of borrowing money under this window had increased considerably. Also, RBI has been able to reduce this rate as the dangers of the currency volatility have reduced in the recent few days”.

      It can be elaborated more, but then there is no end to its explanation and my observations could be vastly different from the RBI’s observations.

      1. No Sir.My point was only why increase the rate of Interst on one type of borrowings and reduce on another type of borrowings.The borrowers are same.There appears to be a contradiction and I was hoping you would clarify this apparent contradiction.

        1. Hi Mr. Ramamirthy,

          I think there is no contradiction here and no confusion in Dr. Rajan’s mind. These are two different kind of borrowings for the same borrowers. Like if I require money for just one year to get my home renovated, I wont go for a 20 year property loan, similarly, if banks require money for their overnight tight liquidity, they wont go to RBI for a medium term Repo transaction.

          Due to the RBI’s steps taken in the last 2-3 months, the yield curve has become inverted in the recent times, which means the very short term rates have moved up and the long-term rates are ruling below these rates. To correct this anomaly & to reduce the burden of high overnight rates (MSF Rate) on the banking system, the RBI has reduced the MSF Rate.

          Whereas the Repo Rate is for a longer tenure than the MSF Rate. Raising the Repo Rate means that the RBI thinks the inflation will remain on a higher side in the short to medium term and that is why they want the interest rates to be tightened to control inflation. I hope it makes sense now?

  4. Sir,
    This is a wonderful article. I have few questions

    1) what is g- sec yield. I have heard this since long but never bothered to understand more on this. Can you provide more details on this. Who decides this % ?
    2) The repo rate is applicable to commercial bank and MSF to cooperative society. what is rationale behinf RBI increasing the repo rate and reducing the MSF.The RBI step favours the cooperative bank but not commercial. why ?
    3) Will the tax free bond interest be always less than the g-sec yield ?

    1. Thanks Pradeep!

      1. We’ll try to do a post on G-Secs & its yield.
      2. It is incorrect that MSF is applicable to cooperative society. I dont know from where you’ve got this.
      3. Tax-Free Bond coupon rate is fixed at 55 basis points lower than the average G-Sec yield for the applicable tenure. So, yes, in a way it will always remain lower than the G-Sec yield.

  5. Sooner or later US quantitive easing has to taper down.Do you think it would be good or bad for India when it happens?I feel our Govt has not taken any action to prevent the bad effects.Do you agree?

    1. If Gujarat grows at 8% and Bihar grows at 15%, it is natural for Gujarati Investors to get tempted to invest in Bihar, irrespective of the steps the Gujarat government takes to stop Gujarati investors from investing in Bihar.

      But, if Gujarat grows at 10% and Bihar grows at 11-12%, no matter what Gujarat government does, most of the Gujarati investors would like to invest in their home state only.

      That is what is happening right now. India has lost growth momentum and most importantly it has lost investors’ faith (both domestic as well as global), due to corruption/scams, policy paralysis, postponing critical policy decisions, taking insensible decisions, inefficiency of the ministries to get issues resolved and many other factors.

      At the same time, US & Europe have recovered somewhat. So, the expected differential between the growth has come down to 2% approximately. Whereas the rupee is falling 10-15% in 6 months time. So, it is natural for the foreign investors to withdraw their investments from India once US Fed tapers. The later it is, the better it is.

      At the same time, it gives our govt. some time to get their house in order. Whether our politicians do it or not, it depends on their intention to work or play dirty politics. I think we can very well grow without foreign investors’ money, but we cannot grow with incorrect & inefficient economic/political policies.

  6. With repo rising, and G-sec 10 yr benchmark yield rising, due to underlying drop in G-sec trading price – should we assume that market expects better yields from future bond offerings? Could this pressure upcoming psu tax-free bonds to increase coupon rate? Current best rate is hudco’s 8.76% 15yr for retail.

    1. Hi Amit, Hi Pradeep,

      These PSUs cannot increase/fix the coupon rates on their own. There is a cap on the maximum rates these companies can offer and those rates are linked to the benchmark G-Sec rates. REC’s 8.71% & HUDCO’s 8.76% for 15 years got fixed when the average 15 year G-Sec rates rose above 9% mark. At that time, there was a panic.

      At present, the panic has receded & that is why the MSF Rate has been cut, but the Repo Rate has been increased. At present, I don’t see coupon rates rising further. For that to happen, these benchmark G-Sec rates have to cross 9% mark once again. Keep tracking these rates or keep tracking OneMint.

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