More than at any time in the past, the market seems to be in a transitionary phase. The effect of the variable rate reverse repos is gradually getting reflected in the market rates. The short end rates have all moved up whether it is the overnight rates, or the treasury bill yields. At the long end too rates have edged higher, and they have already touched the target levels of 6.60 which we had projected in our earlier updates. The last auction of the new 10- year benchmark speaks eloquently about the mind of the market. The cut-off at 6.54% and a significant devolvement on the primary dealers means that the market is ready to subscribe to the new issue but obviously at much higher yields. It is worth mentioning here that the last ten-year auction cut-off was at 6.10 % and the present cut-off is much higher than that. The state government securities have also gone past the 7% mark and are set to rise with a bunch of issues hitting the markets in the coming weeks. While the aggressive liquidity management through variable rate reverse repos resulted in the desired results as the RBI obviously wanted the short-term rates to move up. Some of the larger institutions have selectively hiked the deposit rates, and there are first reports of a kind of pick-up in credit growth though still quite feeble. With the short- term rates moving up the reliance on bank credit from corporates may also likely rise as the spread between the bank rates and market rates for corporates with higher credit rating may decline progressively. However, despite all these developments, RBI may not allow rates to flare up as the conditions around the third wave of the pandemic is yet to come under control, and this required caution as lockdowns even in a limited way may cause some disruptions which may not be major. This may also impact growth in this quarter as also the coming one. Therefore, a direct rate action may be delayed by a few months. But a modification of the repo rate with as market rates continue to move up will become inevitable over time.
Inflation remains a matter of concern with inflation at elevated levels in the last three months – CPI based inflation hardened for the month of Dec’21, third consecutive month in a row, the headline inflation for the month of Dec’21 came in at 5.59% as compared to 4.91% in the preceding month and 4.59% during the year ago period. The core inflation remained largely stable and came in at 6.01% for the month of Dec’21 as compared to 6.08% in the preceding month. The fuel component is reason for worry as Brent has moved up to US$ 86, and this may get transmitted to the local prices through the exchange rate. In the minutes of the last MPC meeting the price level was a matter that was discussed for its impact on the economy and consequent need for action. The only redeeming feature is that it is still well below the RBI’s threshold limit. But persistently high price level may invite the central bank’s wrath in the form of a definitive rate action, the probability of which rises with persistence. The market will be eagerly looking forward to the budget mainly for its fiscal consolidation efforts, and the borrowing program, as also resource mobilization programs for the next year. This may have a tremendous impact on the market sentiment, and the size of the government borrowing program will be keenly watched. With weak consumption and investment, the component of aggregate demand which the government can influence is its own spending and this may require market borrowing of the same order as before. Only tax buoyancy and major disinvestments could alter the scenario significantly. Meantime, the focus may continue to be at the very short end of the curve and short-term instruments with striking-distance maturities with attractive yields. The market is in a transitionary phase in many respects, and there will be better visibility as we move beyond the budget and the financial year end.
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