RBI Governor wants markets to keep the faith but traders want something more

• The Reserve Bank of India (RBI) Governor Shaktikanta Das was doling out optimism to the market at today’s Monetary Policy Committee (MPC) briefing.
• The MPC will be expanding the limit of open market operations (OMOs), providing on-tap TLTRO of ₹1 lakh crore, and introducing State Development Loan (SDL) OMOs.
• While these measures may ease some tensions in the short run, the markets still seek predictability and interest rate cuts.
• Das said that both the apex bank and markets can operate in the same space in competition without necessarily being combative.

The Reserve Bank of India (RBI) Governor Shaktikanta Das delivered a chipper note on India’s recovery today. According to him, even though there’s some disconnect between the RBI and the markets, all will be well — soon.

However, what the market participants want is for the RBI to acknowledge that the economy is in deep trouble and, therefore, cut interest rates further, boost money supply, and ease credit.


The deep contraction of economic growth witnessed in the first quarter is behind us, he said, while emphasising that some silver linings are already visible. However, not all that glitters is gold.

“We remain circumspect about generalising these early greenshoots, as they have benefitted from base effects and one-off shifts in some sectors,” said ratings agency ICRA.

Despite Governor Das’ attempt to ease those tense nerves in the market, the argument seems far from over. “The RBI governor's push for optimism is bordering on the edge of hope,” said Sushil Kedia, the founder of KEDIANOMICS. “What's going to happen over the next one month or three is anybody’s guess.”

The question to ask here is not who is right and who is wrong, but what happens if any one of them is wrong. If the markets are wrong and the economy recovers by March 2021, they will be in for a surprise. However, if the RBI is wrong and the economy is worse off than the picture painted by the Governor, the implication may be more dire for everyone in the country.

Not just growth, RBI hopes the inflation wave will also ebb on its own
“MPC has decided to look through the current inflation as a transient hump,” Governor Das explained, adding that inflation will ease between January and March next year.

However, Kedia is less sanguine than the RBI Governor. “The interest rate cycle has been so overstretched and soft for so long, that I do see signals in long term data analysis, that at any point far sooner than one would expect, some global events will start reversal of the interest rate cycle,” he said.

“The relative economic growth differential between China and the rest of the world is almost 13-14%,” he added. The point Kedia is making is that if inflation rises in the rest of the world, even India will have to raise interest rates to tackle the prices, and the RBI is not preparing for it. While not the most obvious possibility, only time will tell if Kedia’s fear is proven right.

RBI’s efforts have been lauded but in parts
While the RBI has opened the liquidity taps time and again, a big concern in the market is that both central and state governments need to borrow more and more to meet the rising expenses due to the pandemic.

The RBI said that it would buy long-term bonds — issued by both states and the centre — on tap worth ₹20,000 crore, up to ₹1 lakh crore in the coming days.

That would provide the money states need, but it will also mop up the funds that would have otherwise been available for private borrowers. In these challenging times, it is believed that lenders would rather give money to a government than risky private parties.

And that would mean that the borrowing rates for private companies will remain higher than what it should have been.

“It also remains to be seen if the commitment to facilitate state and central government borrowing, as well as the explicit signals aimed at softening yields, are adequate for bond markets to shrug off concerns regarding the fiscal health of the central and state governments,” ICRA pointed out.

Back to the demand for another rate cut
Essentially, private borrowers are back to seeking interest rate cuts, which the RBI seems reluctant to execute at this point. “These (measures announced today) should be beneficial for banks who are comfortable with the credits of corporates to lend as banks' borrowing rates are fixed. In case the repo rates are cut again, banks can refinance at lower rates also,” said Murthy Nagarajan, the head of fixed income at Tata Mutual Fund.

Instead of directly cutting rates, the RBI has offered up open market operations (OMOs), which — according to Abhishek Goenka, the founder and CEO of India Forex Advisors (IFA) — will help bring borrowing rates down in the commercial paper market.

OMOs are conducted by the central bank to give or take currency from a bank or group of banks by buying or selling government bonds on the open market. It’s an instrument banks can use to increase or shrink liquidity in the market.

“RBI was doing OMOs on an ad hoc basis,” explained Goenka, essentially saying that while RBI may be taking necessary steps, they haven’t been very predictable. And markets hate surprises.

Until September 30, it wasn’t clear how cash-strapped state governments would find the money to meet the additional expenses in the wake of the pandemic. The markets are glad that RBI has opened up the emergency borrowing window — called ways and means advances or WMA — until the end of the fiscal year by 60%.

WMA essentially means that governments can borrow directly from the RBI to meet their emergency needs. That leaves more money in the market for private borrowers.

While the decision came just in time, there was enough fear and chaos in the run-up to it.

What the markets want are predictability and interest rate cuts. Meanwhile, the Governor has asked the market to keep the faith. “We look forward to cooperative solutions for the borrowing program for the second half of the year… These views can be competitive without being combative,” he said.

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