The MPC has maintained that it will continue with its accommodative stance “as long as necessary to revive and sustain growth on a durable basis.” Key rates have been unchanged since May 2020 as the RBI has been seeking to shore up growth as the economy recovers from the damage caused by the Covid pandemic.
But liquidity is getting squeezed and set to come under further pressure – the RBI may raise the quantum of funds it’s absorbing from the market with reverse repo auctions and a likely sell-off by foreign investors could lead to a flight of capital.
Benchmark yield has surged as much as 87 basis points since May 22, 2020, when the gauge hit a near-term low of 5.72% during the first Covid wave. During that period, shorter-duration sovereign paper with tenors up to 12 months yielded 37-90 basis points higher.
“There is a clear divide between institutional and market rates,” said Madan Sabnavis, chief economist, Bank of Baroda. “While institutional rates fell, giving fruition to the RBI’s policy stance, market rates instead have gone up. The MPC should align the rate trajectory by narrowing the gap between repo and reverse repo, which should be a hike in the reverse repo rate. This is unlikely to hurt growth, which as we have seen is no more a function of rates.”
The median marginal cost of funds-based lending rate (MCLR) gauge for commercial banks was at 7.85% in May 2020, dropping 60 basis points at the end of December last year.
“Rising yields amidst accommodative stance shows tacit normalisation from ultra-loose to loose stance,” said Soumyajit Niyogi, associate director at India Ratings. “The market seems to have started giving signals of discomfort over the high fiscal deficit.”
Surplus cash in the banking system is now at ₹6.64 lakh crore compared with ₹8.33 lakh crore more than four months ago. Since May 22, 2020, the repo rate, at which banks borrow short-term funds from the central bank, has been unchanged at 4%. The reverse repo, at which banks park excess funds, has stayed at 3.35%.
“Even though the central bank has not raised policy rates, the market started factoring it and also following the unwinding of surplus liquidity in the banking system and global yield rises,” said Ajay Manglunia, MD, JM Financial.
“Borrowers will have to fork out higher cost well before RBI’s formal beginning of rate hike cycle.”
The differential between triple-A rated private sector companies and the benchmark gauge is at 80 basis points compared with 60 basis points in May 2020.
Although spread expansions were not large, corporate borrowers have paid much higher rates in absolute terms. Every such borrowing is linked to the sovereign benchmark yield.
Also, market borrowings dropped significantly in the aftermath of the first wave of infections in 2020.
India’s largest mortgage lender HDFC Ltd is yielding about 7.20-7.25% for 10-year paper compared with about 6.80% about 21 months ago, dealers said. The differential between triple-A rated public sector entities and benchmark paper is now at 70 basis points versus 60 basis points about 21 months ago.
Foreign portfolio investors sold debt securities worth a net $250 million in the local market in January. With US treasury yields rising, the trend may accelerate amid winding up of easy liquidity. Between October and December last year, they sold local securities worth a net $5.9 billion, according to data from NSDL, a depository.
The US treasury benchmark has shot up by about 25 basis points since the beginning of this calendar year to 1.77%.
