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RBI Policy: We Are Not Giving You 50 Lakh Rupees But We Will Buy Lots Of Bonds


In Raghuram Rajan’s last policy statement, he hasn’t changed rates at all. We spoke of this in our (premium) post and many things that’s been said have been items we speak about constantly at Capital Mind.

Liquidity: RBI Will Buy Bonds

RBI will buy bonds to inject liquidity into the system. The FCNB(B) they mention is a long standing event we have discussed at Capital Mind. (The Story of the FCNR Swap)
This will result in about $26 billion returning to NRIs in September – November 2016. That’s about Rs. 200,000 cr. which is a massive amount of money. When that happens, it’s quite likely that the liquidity situation in the rupee market goes into a deficit. Why? Because banks, to return dollar deposits to NRIs will go to the RBI to exercise their swap – and give the RBI rupees and take dollars.
Rupees with the RBI is essentially like rupees that are out of the system, so the system sees a deficit. And to bridge that, RBI will reintroduce rupees into the system by buying government bonds and giving rupees in exchange.
RBI will buy bonds
What this will do is also see an increase in prices of bonds. If the RBI’s buying, then the prices get a “floor”. The 10 year bond is at 7.13% and yields are likely to fall a little further, we think.
They will buy Rs. 10,000 cr. of bonds on Thursday.

Housing in CPI Goes Up Because of Pay Commission

They say:

In addition, the full implementation of the recommendations of the 7th central pay commission (CPC) on allowances will affect the magnitude of the direct effect of house rents on the CPI.

Which means: the housing component of the CPI is measured largely by what government employees pay as rent, and that component (through HRA) goes up due to the pay commission recommendations. That means inflation will seem higher.

Rajan Says Banks Are Making Flimsy Excuses for Not Cutting Rates

He says it best:

Despite easy liquidity, banks have passed past rate cuts into lending rates only modestly. Earlier, some bankers said that it was the lack of liquidity that was holding rates high, now I hear from some that it is fear of the FCNR(B) redemptions that is making them reluctant to cut rates. I have a suspicion that some new concern will crop up once the FCNR(B) redemptions are behind us.

Banks won’t find it easy to made excuses forever, but then, they have been doing so and RBI can’t force them to cut rates.
And then there’s going to be guidelines for P2P lending, and measures to improve the functioning of bond markets.
Finally, he ends with a suggestion:

Second, if you get an email from me or any future governor promising to transfer a large sum of say ₹ 50 lakh to you if only you send a small transaction fee of ₹ 20,000 to a specific bank account, delete the email. The reality is such emails are not from me and the RBI does not give out money directly to ordinary citizens, even though we print plenty of it. While the emails usually contain very convincing reasons why you have been chosen to receive money, ask yourself why I cannot simply deduct ₹ 20,000 and send you ₹ 49.8 lakh. If you think for a moment, you should not fall prey to such emails.

Rajan’s been a fun guy!

Our View:

The policy wasn’t complicated. It’s never supposed to be. Keeping rates flat was also expected by everyone.
However, what is important to note is that Rajan made it such that policy is easily on expected lines. Unlike the drugged central bankers of the west who seem to crave all attention by using things like “bazooka” QE and all that, Rajan kept things simple and therefore no one has to be super-surprised by what the central bank has to do. Capital Mind has favoured Rajan’s thoughts on way too many occasions, and disagreed on some – but overall, this is one of the best central bankers we’ve had, and let’s hope the next one is as good or better. (Thank you, Raghuram Rajan, for all the great work and specifically, for opening up government bonds for retail customers).


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