Q: Will RBI’s liquidity measures have the desired result?
By creating additional demand for government bonds, OMO is also likely to soften bond market yield. We expect the 10-year benchmark yield to fall to 7-7.25% range in the current fiscal from 7.4-7.5% now. Better liquidity would aid banks, softer bank interest rates to help corporates (especially those in interest sensitive sectors and solvent companies with high leverage) and retail borrowers and lower yields would help the government.
Q: RBI has narrowed the rate corridor to 50 basis points -- what does this mean?
This would reduce interest rate volatility in the money market as the spreads between both repo and reverse repo rates, and also marginal standing facility (MSF) and repo rate would go down from 100 basis points to 50 basis points. The 75 basis point cut in MSF rate coupled with relaxation of daily CRR balance requirement means banks would have greater flexibility in liquidity management. This would allow banks to maintain high credit growth even with transitory dip in deposit growth.
Q: Your overall analysis on RBI’s policy?
The RBI has drastically changed the stance on systemic liquidity. It is moving from the preference for a tight liquidity situation to a neutral situation. Policy measures initiated by the RBI today should aid transmission of the past policy rate cuts as well.
The RBI along with the government has created the enabling conditions to bring down bank lending rates. The government is in the path of fiscal prudence (no over-supply of government bonds) and interest rate on small savings schemes have been reduced (eliminating the need to maintain high interest rates for bank deposits).
Along with 150 basis point rate cut since January 2015, RBI has taken measures to improve banking sector liquidity and ease liquidity management by banks. With all these preconditions in place, the imperative for lending rate cut, therefore, is now squarely on the banks.
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