RBI Announces Measures to Stabilize Bond Markets ::Morgan Stanley Research

RBI Announces Measures to
Stabilize Bond Markets
What’s new? Reserve Bank of India announced
measures to stabilize domestic bond markets.
The measures announced on August 20, include:
Open market purchases: The Reserve Bank of India
will conduct open market purchase of long dated g-secs
worth Rs80bn (~US$1.3bn) on August 23, and it will
calibrate the purchase both in terms of quantum and
frequency, as may be warranted by the evolving market
conditions.
Measures on prudential adjustments for banks: The
hardening in long end yields and consequent mark-to-
market losses for banks led the RBI to announce the
following:
 Allow banks to retain SLR (statutory liquidity ratio)
holding at 24.5% of their Net Demand and Time
Liabilities (NDTL) in the held to maturity (HTM)
category (vs. earlier requirement of 23% over time).
 Allow banks to transfer SLR securities to the HTM
category from available for sale (AFS)/held for trading
(HFT) categories up to the limit of 24.5% as a
one-time measure. Banks can shift these bonds at
prices as of July 15, the date of the first RBI action.
 Banks can spread the net depreciation, if any, on
account of mark-to-market (MTM) valuation of
securities held under the AFS/HFT categories over
the remaining period of the current financial year in
equal installments.

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What’s the objective of these measures?
(a) Clarity in tightening of short-term rates vs. long-term
rates: We believe that the announcement of open market
purchase operations aims to stabilize the long bond market,
which has seen huge volatility over the last few days. The
statement released by the RBI on August 20, clarifies that the
intention of RBI’s tightening measures announced earlier were
to lift short-term rates and that it would keep short-term rates
anchored to the marginal standing facility (MSF) rate of 10.25%
(300bp higher than levels at 7.25% on July 15).
To this effect, the statement notes that money market rates are
now anchored to the MSF rate of 10.25% and RBI will calibrate
the issuance of cash management bills (CMB, which were
announced from August 8), including scaling it down to keep
money market rates around MSF rate.
The statement just released clearly conveys RBI’s intentions to
keep short-term rates elevated until the currency volatility
reduces. However, RBI wants to ensure that uncertainty on the
rate outlook does not cause excessive volatility in the long
bond market.
(b) Avoid risk aversion in the banking system due to
losses on long bonds: We believe that RBI’s move to allow
banks to transfer securities to the hold to maturity (HTM)
category (at July 15 valuations) and spread the losses for the
securities that can be transferred over the rest of the financial
year is an attempt to reduce the capital hit of banks, especially
SOE banks. RBI’s statement clarifies that these measures aim
to prevent adverse effects on the banks’ ability to provide credit
to the productive sectors in the economy. We believe these
measures, whilst taken up with the right intentions, reduce
transparency on the banks’ book value.
How long will short-term rates remain high? We believe
that India will remain exposed to the trend of the US dollar and
real interest rates as long as India’s current account deficit
remains higher than a more sustainable level of 2.5% of GDP
(implying trade deficit at ~8.5% of GDP) and CPI inflation
remains higher than 7%. In the near term (over the next four
months), while we do expect some moderation in CPI inflation
and current account deficit, it will remain high. During this
period, the rupee and interest rate environment in India will
remain highly dependent on the trend in US real rates and US
dollar. (See our note India Economics: Longer Duration
Slowdown Risks Vicious Loop)