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Wednesday, July 24, 2013

RBI’s liquidity squeezing – a guest post

Vote-bank politics with schemes like NREGA, food securities bill, and hugely hiking the pay of government employees – not to speak of fertiliser subsidy, oil subsidy – has led to a bloated fiscal deficit in India.

Slowdown in global economies – including in India – and rising oil prices have added to the Current Account deficit. Instead of taking pro-active steps to curtail the twin deficits and put GDP growth back on track, the government tried to coerce RBI into reducing monetary controls to re-energise growth.

Instead of succumbing to pressure, the RBI Governor stuck to his hawkish stance against inflation. He is paying the price by not getting an extension of his term in office. His latest step to stem the fall in value of the Rupee by tightening liquidity has not been well-received by the stock market.

In this month’s guest post, Nishit discusses the likely effect of RBI’s action on Gilt Fund yields.

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Recently, the RBI indirectly raised Interest Rates by squeezing liquidity to curb the pressure on the Rupee. This led to a spike in bond yields from 7.5% to 8.1%. Many of the debt funds lost 3-4% of their NAVs. Many must have panicked, as this had never happened before and can almost be called a ‘Black Swan’ event.

So what does it mean for Gilt funds going ahead? The basic objective of Gilt funds is that they are meant for long term investors when the interest rates are coming down, to capitalize on the increase in Bond Prices when yields come down. One is supposed to exit when the trend has changed and the bond yields are going up.

Was RBI’s intervention a signal that Interest Rates may be going up? I do not think so. The economy is in shambles and to simulate the economy, rates have to come down. RBI’s action was just a one-off blip as a desperate government tried to stop the Rupee from devaluing further.

Bond Yields, which had spiked to 8.1% towards the end of the week, came down to 7.9%. If there are no more unpleasant surprises, then the yields could touch the record low of 7.1% by December. The spike in yield was a buying opportunity for the long term investor.

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The very fact that the yield rose from 7.56% to 8.10% and back to 7.94% means that the market had over-reacted and yields are coming down.

The RBI policy on the 30th of July ‘13 will give further guidance on what the RBI intends to do. As I see it, they will maintain a status quo and will neither raise nor cut Interest Rates.

In real terms, home loan rates will not come down. The Auto or the Realty sectors’ hopes of a stimulus will have to keep waiting.

Long-term investors do not need to worry. Only short-term traders, and Banks who conduct treasury operations, will take a hit. Till the economy turns around, I do not see Interest rates rising.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)

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