The Reserve Bank of India has made an interim announcement to cut the marginal rate to 9% from 9.5%, effectively lowering bank costs of funding.
Since Repo borrowing was limited to 0.5% of Net Demand and Time Liabilities (NTDL) - which is the sum total of the deposits banks have - banks had to borrow the excess through the Marginal Standing Facility.
The MSF Rate was first 10.25% on July 17, and was cut to 9.5% on Sep 20.
Today it’s down to 9%. The market hasn’t really reacted, since it cannot. These measures have been announced after equity, debt and currency markets are closed.
We can treat this as a drop in rates. However, MSF borrowing has been falling suddenly after the spike on Sep 30:
Effectively, the drop has brought it to substantially lower levels, so liquidity pressures have eased. It’s not apparent, however, why the RBI chose to call this easing liquidity - because liquidity is much easier than earlier already.
New 7 and 14 day repo announced
In a new twist, repo - which is money borrowed from RBI overnight (or 3 days on weekends) - there will now be 7 and 14 day repo borrowing. The extension will give banks a clearer picture on how much interest they pay for a longer time, and also increase the quantum of borrowing to another 0.25% of NDTL. (Currently overnight repo is limited to 0.5% of NDTL)
The statement is that RBI will:
Provide additional liquidity through term repos of 7-day and 14-day tenor for a notified amount equivalent to 0.25 per cent of net demand and time liabilities (NDTL) of the banking system through variable rate auctions on every Friday beginning October 11, 2013. The notified amount and tenor of the term repo auctions will be announced prior to the dates of the auctions.
What we don’t know is the rate at which these repo will be given. I assume that they will be similar to the MSF rate, so around 9% is what I expect.
Impact and Questions
- Positive for banks in the short term and probably the whole market.
- Inflation is likely to remain high - and the numbers will come in starting October 12. What happens then?
- I wonder what prompted this move, especially looking at the chart above. It could be that bank losses will be very large on the bond move and liquidity pressure. Reading between the lines, banks might be in much deeper trouble than we think.
- CPI inflation is running at 9.5%+. WPI is at 6%. I wonder what has prompted the RBI to provide marginal liquidity at 9%, versus the 9.5% it was at, given that the RBI governor has mentioned that CPI is in his view the target inflation metric. Does this mean he’s giving up on CPI?
- Why is this a mid-month measure? Is this something being done because there is something horrible about to happen and we don’t know about it? Remember when the RBI introduced these measures on July 17 - another mid-month measure - we really didn’t know why - until the rupee absolutely TANKED after that, from Rs. 60 to Rs. 68. What does the RBI know?
For the trader, this is not a great time to be short. But if I were to read between the lines, the RBI seems to be preparing for a really bad announcement or move in the days to come. I would stay nimble. (Disclosure: long banks).