Liquidity, repo cuts not enough to keep market rates low: Arun Srinivasan

If inflation doesn't ease, the RBI may be forced to take its first step on unwinding as early as February with an increase in reverse repo rate.

ETMarkets.com
“Any further interest rate cut from current levels is unlikely to push credit growth. It is the risk aversion prevalent in the market now that needs to change for reversing the sentiment,” Srinivasan said.
Mumbai: Surplus liquidity and rate cuts are not sufficient to keep the market rates low for long given that inflation is on the rise, said Arun Srinivasan, executive vice president – head of fixed income, at ICICI Prudential Life Insurance.

If inflation doesn't ease, the RBI may be forced to take its first step on unwinding as early as February with an increase in reverse repo rate.

“We are practically at the bottom of the interest rate cycle,” said the fund manager who managers 94,000 crore in debt assets. In February 2021, the market could see an increase in reverse repo as a first sign of a changing interest rate stance.


“Any further interest rate cut from current levels is unlikely to push credit growth. It is the risk aversion prevalent in the market now that needs to change for reversing the sentiment,” Srinivasan said.

The latest steps from the RBI at the aggressive levels is a positive affirmation that the central bank would come with full might whenever it is required. It instils confidence in the market that more measures can be expected from RBI if yields continue to show signs of rising, said the head of fixed income at the insurance company.

“Market is keenly looking at how the government will fund its fiscal deficit for this financial year,” he said. The economy was anyway in a slowdown before the onslaught of the Covid pandemic. The lockdown has further worsened the situation.
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It is broadly expected that the deficit from the GST collections will be quite substantial for the year. Given this backdrop, the second half borrowing by the government will be the key determinant of the trajectory of bond yields from here on,” he said.

RBI’s held-to-maturity move could increase demand for government bonds from banks. The regulator can tinker with the statutory liquidity ratio. While these measures would be helpful for the government to raise funds from the market, it will defeat the basic purpose of lending to businesses, Srinivasan added.

It is quite surprising that the bonds of state governments, including financially sound states such as Tamil Nadu, Telangana, and Kerala are trading at yields higher than the bonds of some of the top-rated public sector companies. State governments have limited sources of revenues in the light of the ongoing COVID pandemic. It is widely expected that the borrowing requirement of the states for this fiscal year will be huge, he said.

This concern is weighing on the yields that the market is demanding from the states. An open market operation by RBI for states, in line with central government bonds, can lift the sentiment for state bonds, Srivasan said.
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“While surplus liquidity has helped all non-banking finance companies, primarily this liquidity has helped them with just their refinancing needs,” he said.

“In my view, unwinding of the policies will begin with a narrowing of the corridor between the repo and reverse repo rates.”
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