RBI Tightens Liquidity

The RBI has tightened bank rates in the country. This time it has increased the bank rates by 200 basis points which implies that short-term loans will get costly. The strong market reaction itself is indicative of how the economy will suffer from this decision. The broader markets are down by 1.2%, while Bank Nifty is down by 4.5% at the moment. The markets are likely to remain volatile following this development and the interest sensitive sectors such as Banking, Auto and Realty would also come under pressure.

The RBI has taken this step to support the rupee. The INR has depreciated by more than 9% on a YTD basis and has seen nearly 13% decline against the dollar in the recent past. The huge exodus of FIIs from the country and speculative bets on the rupee have been the main reasons behind this. Many experts are still of the opinion that the rupee would remain lower in the range of Rs 65 against the dollar going ahead. The news of tightening of liquidity by the Federal Reserve through the tapering of the QE has caused chaos in the global markets. Following this, many currencies have shown a weak performance and rupee depreciation has been one of those unfortunate currencies.

The measures taken by the RBI includes increasing the rates of Marginal Standing Facility (MSF) by 200 basis points with immediate effect. The MSF rates would now stand at 10.25%. Under the MSF, scheduled banks can borrow funds from the RBI overnight. Banks use this facility when they need immediate cash. This rate is 1% above the repo rate. Currently the repo rate stands at 7.25% and hence MSF would stand 3% higher at 10.25%.

Similarly, bank rate which is a short-term tool of the RBI to lend money to commercial banks has also been increased by 200 basis points to 10.25%. The RBI has also limited the allocation of funds under the liquidity adjustment facility to just 1% of the total deposits of the bank which would be Rs 75,000 crore. Further, the bank will also hold open market operations to sell the Government of India Securities of Rs 12000 crore on July 18, 2013.

One of the main concerns for the market is whether the RBI will cut the repo rates in July 2013. Yesterday's WPI numbers and last week's IIP numbers had again raised the expectations of a rate cut but now there is absolutely no chance that the RBI will cut the rates. Madan Sabanvis, Chief Economist at Care Ratings said that he does not expect any repo rate cut in the policy meeting in July or the one after this. He, however, said that towards the end of the year there could be some hopes of cutting the rate but it is highly uncertain and depends upon how the economy propels going ahead.

Overall, the tightening of the rates may prove to be a hammering for the markets as it will increase the short-term loan rates, although temporarily. The rupee has also begun to appreciate but the story of the economy has now become objective, wherein you tighten the rates to curb inflation or stabilise the rupee or lower the rates for growth. The RBI, it seems, may be heading towards the unknown by doing this. The investment sentiment overall has taken a beating and unfortunately, things look quite negative in the terminal year of the current government which is not willing to do much expect for introducing a few reforms.