RBI Announcement – Marginal Standing Facility (MSF) Rate Increase – Cap on Infusion of Liquidity through Liquidity Adjustment Facility (LAF) – Open Market Sale of Government Securities – Immediate Market Impact – OUR VIEWS OUTLOOK INVESTMENT STRATEGY The RBI on 15th July 2013 announced a series of measures to rein in domestic liquidity with the objective of managing & curtailing volatility in Indian Rupee. The RBI increased the MSF rate by 200 bps to 10.25%. (MSF Rate was earlier 100 bps over Repo Rate which has been increased to 300 bps over Repo Rate). Rate Earlier Now Repo Rate 7.25% 7.25% (No Change) Reverse Repo Rate 6.25% 6.25% (No Change) MSF Rate 8.25% (100bps over Repo) 10.25% (300 bps over Repo) Funds available under repo window will be capped at 1% of Net Demand and Time Liabilities (NDTL). Based on this cap, presently this figure stands at approximately Rs 75,000 crores The RBI will conduct Open Market Sales of GOI securities of Rs 12,000 crores on July 18, 2013 The timing of announcements took markets by surprise leading to a knee jerk reaction with short term yields inching up by over 100-150 bps in morning trades and long bond yields moving up by about 50-60 bps. Liquidity came under strain as banks sought to shore up liquidity ahead of the LAF limit being effective from 17th July 2013. The benchmark 10Y Gsec Yield inched up above 8.00% and was trading at 8.04% compared to close of 7.55% on Monday. Rate As on July 15, 2013 Post Announcement Trade Levels 3M CD 8.02% 9.25% -9.75% 3M CP 8.43% 10.40%-10.50% 5Y AAA 8.75% 9.335-9.45% 10Y GOI Bmk 7.55% 8.05% - 8.10% • Though the borrowing costs of banks is expected to go up after these announcements, still upward hike in MSF rate is not a rate hike but a liquidity adjustment measure • Banks have been borrowing about Rs 85,000 – 90,000 Cr on a daily basis under LAF over last couple of days. With this cap of Rs 75,000 crores, banks will now have to borrow from money market or take recourse to MSF for this additional borrowing. The call rates will move up as and when the money market liquidity deficit exceeds LAF cap of Rs75, 000 crores. • According to the RBI, “The exchange rate pressure also evidences that the demand for foreign currency has increased vis-à-vis that of the Rupee in part because of the improving domestic liquidity situation • To summarize; these measures are explicitly aimed at reigning in liquidity by making it costlier to borrow in Indian Rupee. RBI expects that these measures will stem pressure on INR. (As cost of supply/supply of INR becomes tight it will become unattractive to borrow in INR to buy USD) • Further, the Open Market sale of Gsec of Rs 12,000 crores will again reduce liquidity in the system. So far the RBI had been injecting liquidity through open market interventions • We believe that the markets were taken by surprise by timing of these measure and hence the panic reaction. The current yields imply a hefty uncertainty premium • We however believe that these measures should be seen for what they are, liquidity management measures with the objective of supporting liquidity and a view on direction of interest rates cannot be firmed based on these measures. • These measures will have impact on credit spreads (widening) as liquidity premium will lead to banks being incrementally discreet in lending to corporate. Corporate borrowers with lower credit rating may be forced to look for non-bank funding • We see these measure as a liquidity management exercise, aimed at stabilizing Rupee, than an indication of direction of interest rates. • We believe that these measures are of temporary nature, and will be reversed once the pressure of Rupee eases • GDP growth close to 5.00% and marked decline in Inflation (WPI as well as CPI) over last couple of months, makes a strong case for monetary policy support • With the recent moves, we may also expect some respite on the ‘imported inflation’ and its pass through effect • However we expect that at its July policy review, the RBI will maintain status quo on interest rates • Going forward, stability in Rupee will be keenly watched. Stable Rupee along with growth and Inflation holding at current levels is expected to continue to support case for monetary support through rate action to sustain growth even at current levels and to give it momentum • We believe after today’s knee jerk reaction, long bond yields have become quite attractive for investments with a minimum 1Y investment horizon. • A liquidity driven measure typically has less relevance to long bond yields. Today’s sharp rise in long bond yields was also partially because of the additional supply of Rs 12,000 crores through open market operations which was also announced by the RBI • Additional support to long bond yields is subdued outlook on growth and inflation so far being in RBI’s comfort zone • As market come to terms with the new supply, we believe the long bond yields will ease gradually as long term investors like Insurance Companies, Provident Fund etc may be expected to take this opportunity • We therefore strongly recommend investment in dynamic bond funds at current levels with a 1Y investment horizon • At the short end of the interest rate curve, returns are expected to be volatile for some time as markets come to terms with new liquidity regime and till uncertainty over its impact is cleared. However, for new investors, it again becomes attractive to invest in shorter maturity funds as after current mark to market impact, the portfolio yields are expected to become attractive • Investors may also lock into current attractive yields through 1 to 3 Year FMP’s. The present strategy of the fund is based on the current market conditions as explained above. The Fund Manager may change the strategy appropriately to reflect changes in market outlook. However investors may note that there can be no assurance & no guarantee that the objectives of the schemes will be achieved. Investors should clearly note that bond and debt markets are volatile in nature. Investment horizon for this strategy is medium term in nature. Investors should have an investment horizon of atleast 1 Year. There is possibility of lower/negative returns in case the market yields move up after initial investments. Internal views, estimates, opinions of Tata Asset Management Ltd. expressed herein may or may not materialize. These views estimate opinions alone are not sufficient and should not be used for the development or implementation of an investment strategy. The portfolio of the scheme is subject to changes within the provisions of the Scheme Information Document (SID) of the scheme. Please refer to the SID for asset allocation, investment strategy and scheme specific risk factors. Forward looking statements are based on internal views and assumptions and subject to known and unknown risks and uncertainties which could materially impact or differ the actual results or performance from those expressed or implied under those statements.
Posted on: Wed, 17 Jul 2013 15:24:23 +0000
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