Rupee will be in suspended animation for some time: Business Standard 12th April 2021

 ‘When sorrows come, they come not single spies, but in battalions’ (Claudius is Hamlet).

This is the feeling one gets today as the stock market is plummeted, COVID is spreading, vaccination stocks are under a cloud and the rupee went down to Rs 75/$. What's happening, and is there a light at the end of the proverbial tunnel?

It all started with the credit policy where the Reserve Bank of India (RBI) announced a barrage of liquidity measures to pre-empt the possible shortage on account of the large government borrowing programme. It did seem innocuous at first, but the market got spooked. Too much liquidity which is exacerbated by Government Securities Acquisition Programme (G-SAPs) only means that bond yields will go down further. That was enough to spur a rally in the downward direction for the rupee, which started falling. In March, we were worried about the rupee appreciating and now in April the currency is falling and after 75 the expectation is whether 76 will be breached.

Probably not. That's because the currency is being driven by sentiment, which is seldom long lasting. The present conditions do warrant concern, as low interest rates means that investors will not find India attractive. Given that the rates are going up in other western countries on the back of a perceived revival in the economy, they appear more attractive investment destinations. It could also mean that we are missing the boat on this side of the channel.

The fundamentals, too, look less strong today. Growth will slow down, thanks to the lockdowns. Exports may not rise as imports will. Therefore, the current account deficit (CAD) will widen and could reach 1-1.5 per cent of gross domestic product (GDP). Foreign portfolio investors (FPIs) may no longer provide succour and while foreign direct investment (FDI) will continue; external commercial borrowings (ECBs) will not until such time the investment cycle turns around.

So, the rupee will be in suspended animation for some time. While a value of Rs 74-74.5/$ looks fair, one can never tell. The RBI may have to intervene if the rupee crosses the 75 mark and edges upwards. But this can be taken to be more transient than a permanent shock.

How about bonds?

With the surge in liquidity which is being topped at the brim with GSAPs, yields will remain low as bond prices inch upwards. This seems to be the unintended consequences of trying to stabilise yields which has led to bond prices going up.

The 10-year bond, which was expected to cross 6.5 per cent under unchanged liquidity conditions during the course of the year, has actually come to the 6 per cent level on Monday - almost 12-14 basis points (bps) lower than at the time of the policy announcement. After the first GSAP transaction, there could be a further dip to less than 6 per cent. The market is finding it difficult to digest all these changes, but the government comes out as a winner as the borrowings will be at a low cost.

A worry will be inflation, which will continue to be in the 5-6 per cent range, as food prices have gone up and global prices firmed up. The assurance given by the RBI that while inflation is being targeted, the monetary arm movement will be towards being accommodative until such time growth looks sustainable is a signal of unchanged repo rate. This is good for bonds, though not so for the currency.

This is an unusual position to be with as normally a falling currency should go with higher interest rates. But this time it is not so, which is why we can expect more volatility in currency for another week or so even while the bond yields remain stable in downward direction.

Sound of MOney: YOu tube channel

 https://www.youtube.com/watch?v=B7BUY8XH2yc

Stock market beats the virus: Financial Express 9th April 2021

 

All through the year, the markets were not too much enthused by government policies as the series of announcements made under Atmanirbhar Bharat campaign drew an indifferent response. The same was with the Union Budget. Therefore, there seems to be more faith put in the private sector and animal spirits than the policies of the government.

FY21 was a dismal year from the economic standpoint, and while the right noises are being made about the so-called recovery, none of these are convincing. A full year had gone by and the state response to virus infection has been the same: Announce a lockdown. It gives a sense of doing something as it stops everything from happening. But there has been one blazing factor in this year of gloom and doom, and that is the stock market.

The new highs that have been reached can be hard to explain, but it is there for everyone to see and from a level of 29,468 in March 2020, a gain of 70% has been achieved. Hence, as the economy collapsed and the virus spread, if one sat back and invested in the Sensex in March, the gains would have been amazing. And what is surprising is that there have been justifications for the same by the market movers, which include India Inc and the stock market experts who talk to us on a daily basis.

Arguably, the March 2020 level was low on account of the announcement of the lockdown at the national level. But the Sensex recovered and reached the 32,400 level by May, which was when the lockdown was severe, and the migrant issue was at the fore. Once the unlock was announced even as the infection cases rose, the market was impervious to these numbers and marched past 38,000 in August, as the seven-day moving average of infections were as high as 74,000 that month. There was a nervous kind of stagnation in September when cases peaked at above 80,000. Since then, the number of cases came down and the Sensex averaged 50,000 in March as the moving average in the last week came back to a new peak of more than 60,000.

Quite clearly, the number of infections had little to do with the stock market movements. The coefficient of correlation between the two variables was +0.24, and while the level was low, the positive sign is what upsets rationality. It is clear that the market does not really bother about the level of infections, and while there are a couple of sessions that witness a decline in the Sensex, it is back to business; it is forward-looking.

When the lockdown was announced and the market went down, one never knew how things would shape up. The quick indicator that was available before corporate results came out and the GDP estimates came in related to tax collections, which were abysmal as no activity meant no income for the government. Corporate results came out by August and these pointed towards the downward direction. Yet the markets were positive. The sharp fall in GDP also did not lead to any correction, and while September was more or less unchanged, the spirits were still undaunted. Since then, there has been an upward move culminating in the 50,000 level in March.

If one were to try and rationalise these movements, it has to be put in the context of forward-looking perspectives. This is where the language spoken by India Inc during the announcement of their results and the relentless advice given in the media on various sectors and stocks make a difference. In fact, the experts in the markets are really market-makers as they keep the spirits up and are always positive. This is rationalised by the earnings growth which is compared with the price and the gap provides scope for the increase in prices. This is not just an Indian phenomenon, but also a global one, as all stock markets have worked the same way. A lot of drivel involving the shape of the recovery is discussed the stock markets move on comfortably, and by the end of the day the two reinforce one another. Just as there is the explanation that the K-shaped or V-shaped recovery is driving the market, the experts on the other side use market movements to justify the view that the recovery is imminent.

In India, at least a part of the rise in the indices could be attributed to the infection cases going down. But in the US the markets did well notwithstanding the infection levels going up, as two other factors played a role. The first was the outcome of the US elections, and the second was the growth prospects of the economy that were revised upwards. This was contemporaneous with the creation of the vaccine, which brought a lot of hope and gains in the market, and this thought still is driving markets everywhere. The second wave in Europe was quite severe with the responses being similar with lockdowns being announced. But the markets moved on.

Where will the market go? The Q1 results of corporates were downbeat with sales and profits falling. Q2 saw sales fall but profits rise, as companies cut on costs, especially labour costs. Q3 saw a marginal growth in sales but profits continued to zoom, which gave a sense of sharp recovery. Q4 will probably be a repetition of Q4 with a better sales growth due to the low base effect of Q4FY20. The announcements of localised lockdowns shake the market but do not really change direction for more than a few sessions. The market is driven more by the vaccination numbers and the high frequency indicators such as GST collections, PMI, e-way bills, etc. Therefore, it looks unlikely that the Sensex will slip too much for a prolonged period of time.

In fact, corporate results will be more than positive in the first two quarters of FY22, which is good news for the market. There would be sectoral imbalances as the services segments will continue to be hit adversely. But the Sensex is dominated by the blue-chip stocks in the manufacturing and IT sectors.

Interestingly, all through the year, the markets were not too much enthused by the government policies as the series of announcements made under Atmanirbhar Bharat campaign drew an indifferent response. The same was with the Union Budget. Therefore, there seems to be more faith put in the private sector and animal spirits than the policies of the government, which is a surprise. But then the history this year of the stock market has been one of surprises for sure!

on TV

 On CNBC

https://www.cnbctv18.com/videos/economy/experts-discuss-economic-impact-of-new-covid-restrictions-in-maharashtra-8830611.htm

Tweak the formula for small savings rates: Business Line 6th April 2021

 

There’s a need to de-link the small savings rates from the G-Sec market. Also, the setting period needs reconsideration

The announcement relating to further lowering of the small savings rate did come as a shock to those who depend on fixed income for a living. This would have been a double-whammy as rates were lowered by 70-140 basis points (bps) last year and the new cuts were in the range of 90-110 bps.

https://www.thehindubusinessline.com/opinion/tweak-the-formula-for-small-savings-rates/article34255379.ece

RBI has been pragmatic on growth; ring-fenced the liquidity issue: Business Standard 7th April

 The Monetary Policy Committee (MPC) decision on rates was quite expected and hence the status quo was not a surprise for the market. The same holds for the accommodative stance, which means that growth will remain the main objective, as the MPC has stated that this stance will hold until growth prospects stabilise.

The focus was to be more on the language of the RBI on growth and inflation. Here, the RBI has been pragmatic on growth with a forecast of 10.5 per cent for fiscal 2021-22 (FY22), which is quite timely. The International Monetary Fund (IMF) had just spoken of 12.5 per cent growth, which looks less likely given the recent developments taking place. However, the RBI has spoken very positively on the growth situation based on the high frequency indicators available, which is open to debate given the series of lockdowns we have had in various states. The RBI has a lot of confidence that the measures invoked by the government last year will bear fruit this year, which is encouraging.

On inflation, the central bank has talked of CPI being above 5 per cent till September and the rationale is assuring. The kharif crop and movement of international commodity prices will have a bearing on the progress of prices. The RBI has again suggested that the government does something on fuel taxes, as this has potential to lower not just the primary effect, but also the secondary impact on inflation of other goods that got affected due to transport costs going up.

Admittedly, these inflation numbers are getting support from the base effects as last year it was high for the first three quarters. Therefore, numbers of 5.2 per cent in Q1 and Q2 should be interpreted against this background. The expectation is inflation will come down to 4.4 per cent in Q3 presumably on the back of a good crop. The assumption is that there will be no onion or tomato-price shock this time!

The RBI has done a mammoth operation of managing liquidity last year, not just for government borrowing, but also the corporate bond market through the targeted long-term refinance options (TLTROs) and other facilities. This will continue in FY22 too.

There are however, two interesting new measures to be taken at managing liquidity. The first is drawing down liquidity in the system, which cannot be put to use through the variable rate reverse repo (V3R) for different maturities. Depending on the quantum and persistence of surplus liquidity in the system, these reverse repo operations would be undertaken. To speak clearly to the market, the RBI has said that this measure is no way a signal for tightening policy as was interpreted last time. Such blunt talk is helpful.

The other is the GSAP – Government security secondary market acquisition programme. This will be a planned open market operation (OMO) kind of action, where the first has been announced for Rs 25,000 crore for April 15. Clearly, the RBI is ring fencing the liquidity issue on both sides - being either surplus or deficit - given the large borrowing of the government. It has been stated that this will keep the yield curve stable and free from volatility. Therefore, two objectives will be met at one stroke.

The RBI has set the tone for the year and we can expect more of these GSAP measures and maybe even TLTROs when the need arises. So, it will be again liquidity management while keeping an eye on inflation and growth all the time.

Cash Reserve Ratio: Should the CRR be retained? Financial Express 3rd April 2021

 

It can be argued that the CRR should remain, and RBI has been fair to banks as the cost of the CRR is permitted to be included in the calculation of the base rate and the MCLR.

With the credit policy coming up next week and the cash reserve ratio (CRR) increase already in force by 50 basis points (bps), it may be time to reconsider the value of having a CRR in place. This also rhymes with what the late Deputy Governor of RBI, KC Chakrabarty, argued for—doing away with the CRR. Today, the net demand and time liability (NDTL) for the banking system is around Rs 160 lakh crore, and 4% CRR means around Rs 6.4 lakh crore is impounded by the Reserve Bank of India (RBI) under this stipulation on which no interest is earned. Further, the markets were quite sensitive to the RBI announcement in the last policy of increasing the CRR in two steps. G-Sec yields were nudged up as it was assumed that the signal was one of tightening rates even though it was pointed out by the central bank that this was not the case. There is compelling reason to revisit this issue.

A CRR has been defined by most central banks because it is meant for solvency of the banking system. If a bank goes bust and there are issues in liquidity, the central bank can use the cash that has been impounded to make the necessary payments to begin with, before using other measures to save the deposit holders. In the Indian case, this has never been used and all bank failures have been caught early by the central bank and action taken. Where the central bank has been caught off guard, the CRR money has not been deployed to pay the deposit holders. In fact, there have been restrictions put on withdrawals and the CRR was never used for this purpose. The deposit insurance scheme is already there to address issues of safety of bank deposits. Therefore, the solvency explanation is not too strong.

The other justification for the CRR is that it is part of monetary policy toolkit, and by increasing or decreasing this ratio, RBI can manage liquidity. Hence, unlike repo rate where changes can only nudge the banks to follow suit, a CRR change deals with the supply of liquidity directly, which, in turn, affects interest rates. Intuitively, if the CRR is increased, the supply of lendable funds falls and rates would go up. Unlike repos/reverse repos which are of a short tenure or OMOs which are of smaller quantities, the CRR is a permanent deal with liquidity. Therefore, the impact is sharper here. Quantitative measures like the CRR have an advantage of being large and direct, and hence effective. However, it is a one-time shot. And once the CRR change is absorbed by the system, a reversion to earlier equilibrium is possible. OMOs, on the other hand, are smaller doses which can be used periodically to steer the market.

Globally, the CRR exists and is as high as 17% in Brazil, 11% in China and 8% in Russia. These rates are much higher than in India (which will soon be 4%). It is nil in the US, 1% in the UK and 2.5% in South Africa. Therefore, there are different ratios in countries depending on local conditions. But the concept is not alien.

Now, bankers would always argue that the CRR should not be there. The idea of collecting deposits is to lend the money to the productive sectors. By impounding funds through the CRR, there is loss of liquidity. Here it can be counter-argued that banks anyway are never lending all their funds and are investing in government securities far in excess of what is required, either out of regulatory pressures of Basel III or preference for the same. Therefore, even if they had these funds, it would not have been necessarily used for credit deployment. In fact, in FY21, RBI had lowered the CRR by 100 bps, which would be roughly Rs 1.5 lakh crore, which could be matched with large reverse repo deployments through the year (of the order of above Rs 5 lakh crore on a daily basis). Hence, the original objective of lending to industry was never achieved as the money went back to RBI and earned 3.35% interest. But the market was happy that more funds were permanently made available to the system.

Then there is the question of interest payment on the CRR. Earlier there was an interest paid on CRR balances till 2007. This made sense when the CRR was in the double-digit range. Now, while demanding an interest payment on CRR payment is legitimate, it should be realised that banks actually have around 9-10% of their deposits that are rolled over continuously as demand deposits. No interest is paid on these deposits, but the funds are deployed for lending as there is stability in these deposits, just like savings deposits which are around 25% and cost not more than 3%. It can be argued, therefore, that as money is fungible, the 9% demand deposits that come free of cost have a part withdrawn through the CRR by RBI which is interest free. Hence, banks are not really losers given the inherent structure of banking in India.

On balance, it can be argued that the CRR should remain, and RBI has been fair to banks as the cost of the CRR is permitted to be included in the calculation of the base rate and the MCLR (Marginal Cost of Funds Based Landing Rate). Therefore, the cost is loaded finally to the borrower and not really borne by the bank exclusively.

The purpose so far has mainly been to use the CRR as a monetary policy tool rather than a final recourse for failing banks. In this situation, a pertinent question to ask is, can these funds be used for some productive purpose? It is important because even forex reserves which are accumulated by the central bank are deployed in federal bonds or other investments. Here, the existing balance of, say, Rs 6 lakh crore is idle, and it is possible for these funds to be deployed by RBI. These funds can be partly used for zero-cost emergency lending to the government for short-term periods including WMA (ways and means advances) which have the advantage of not leading to creation of new reserve money. Probably RBI can decide on what part of the CRR can be used for these purposes while the base CRR money which can be defined as being 50% is used for monetary policy purposes. How about lending to the new development finance institution (DFI)? It cannot be for the long-term and has to be for the short-term only because otherwise the conduct of CRR tool for monetary policy will be impeded. A discussion needs to start on this subject for sure.