India Rates - Steep Curves Ahead
(Reposting my earlier posts as a combined article.)
Rates will be cut this week and the Repo - 10 yr (new) spread will rise to to 150 bps.Without preamble lets look at the reasons.
1. Trust deficit : Banks DO NOT want to lend. Simply because they don't expect the money to come back. When you are recovering from an NPA crisis, battling in NCLT and know that the NBFCs are still struggling why will you lend? This is why despite the surge in liquidity credit spreads are elevated.
2. Bottomless Pit : Yes the govt will meet its deficit target. But in doing so it will use everything in the playbook. Guaranteed Bonds, GOI Serviced Bonds, Debt ETFs. The problem is the end buyers are the same. If the EPFO, LIC, Pension Fund and their ilk are holding so much of this 'structured govt debt', where is the room to lend to industry? This is why the curve will continue to steepen. There is now an enhanced credit / term premium on the sovereign curve.
3. NBFC effect : In the past when rates were cut the NBFCs were the first to borrow cheap through CPs and lend to MSMEs etc. CPs are now a dirty word and ALM gaps are frowned upon. Thus all the short term liquidity stays in t bills where the yields have collapsed.
4. Circular loop : GST is in a loop. Collections are low because the economy has slowed down. And because collections are low the govt has to borrow through other routes which again starves industry of credit slowing it down further.
5. Blinkers on : We still refuse to look at a Sovereign Bond. A country with 400 bln in reserves is not confident of managing the currency risk on a 10 bln issuance. Yes the landed cost in INR of a sovereign bond may be same as a domestic borrowing but it will bring in a new investor and free up local funds for industry. Why is that so hard to see? Instead we prefer the more expensive option of selling PSU equity.
6. The Usual Suspects : The crude and food price bogey is always hanging like an albatross around our necks. If its not Oil its Tur Dal or Onions which keeps inflation perky and the MPC on edge.
Solutioning
I actually don't see an immediate solution though many have been suggested.
1. Steeper cuts : What 135 bps has not done will not be achieved by another 50 or 100 bps.
2. Operation Twist : Don't see it happening. With so many benchmarks getting linked to the repo can't see any move that may cause short term rates to rise. Outright OMOs are a possibility but again they are usually across the curve targeting bonds which banks want to offload from AFS books. Also given the RBI transfer to the govt and high probability of future transfers, do not know if the RBI balance sheet has the capacity to absorb large scale QE.
Banking as we know involves 3 Cs - Character, Capability (to repay) and Collateral. Currently there is an issue with all 3. The NBFC crisis has all been about lack of Character or Governance. Industry as of now does not have Capability to service its debt. Deep, sector specific reforms are probably required. And as far as Collateral goes we can all see the queues at the NCLT.
Its easy to strike a despondent note but the fact of the matter is that we have a patient in the ICU. Unfortunately we have wasted time too much time in Day Care but at least the problem has been acknowledged now and hopefully the Specialists, including the Surgeons will get to work.
#India #RBI #MPC #economy #slowdown #NBFC #OperationTwist #OMOs #NCLT #NPA #QE #ratecut #liquidity
Banking Professional
4 年Spot on Sir. MPC to retain its credibility as Inflation Targeting has to change its goalpost by justifying cuts? by taking shelter under Core CPI or Government 's band of 2% to 6% instead of fixated to 4% durable Inflation. It would require the wisdom of PMEAC to overrule the professional pessimists and go for Listing in Global Indices and or 10bn Sovereign Bonds Issuance without wasting anymore time. Else Term Spread may rise to 165bp even on a Repo of 4.90%. RBI could cap the Reverse Repo Auction Variable & Fixed put together to 50k so that Bank's are forced to buy bonds and the curve flattens
CEO & HR Consultant, Investments Manager
4 年Reluctance to lend by Banks on the assumption that everyone is a thief is one of the biggest setbacks. And to good extent this perception has been hyped by Government agencies as well. The sooner the Bureaucracy wipeout such perceptions the better it'll be.
Derivatives
4 年Insightful article! Banks are also under tremendous pressure in this particular rate cut cycle and are unable to lend because of severe Capital Constraints and Deteriorating Conditions. Fitch Ratings has estimated that Indian banks will require an additional USD 7 billion (about Rs 50,000 Crore) of Equity Capital by FY 21 (2020-21) to support loan growth, achieve 75 per cent NPL (non performing loan) cover, and build a buffer over the minimum Basel III capital standards. Also, the systemic stress across non-banks would deal a significant setback to recovery in the banking sector, reversing recent improvements in performance, and posing solvency risks to banks with the thinnest buffers. From a Stress Test conducted by Fitch to examine this, it is estimated that the scenario would leave banks with an aggregate shortfall of USD 10 billion to meet regulatory minimums, and USD 50 billion below the level that would provide an adequate buffer Deteriorating sectoral and macroeconomic Conditions have taken a toll on Lending by creating a Crisis of Confidence.