MIDNIGHT SUMMERSAULT BY RBI

  

In a move that will rattle the equity markets on Tuesday morning, the RBI took  a series of steps that will seriously reduce the liquidity in the system and raise the costs of borrowing for banks.

The RBI will now

1.   Prevent Banking system’s access  to easy money  and thereby prevent speculation in foreign currency.

2.   Effectively increase borrowing costs

3.   Will STOP  buying of bonds

4.   And now START selling bonds.

5.   Sell bonds worth Rs 12,000 cr on 17^th July in the secondary market to pump out liquidity

6.   Fix the borrowing limit for banks at 1% of the system’s net demand and time liabilities

7.   Limit the borrowing of  the system at Rs.75,000 crore . It will take effect from 17 July.

The move came after FM returned empty handed form the U.S. The Rupee, which had fallen to 61.21 to a dollar earlier this month, recouped some of its losses when the RBI and SEBI ordered pruning of positions in forex trading and disallowed banks from proprietary trading. While some of these measures are yet to take full effect, the Rupee’s renewed slide worried the central bank to come out again with a knife Monday late night.

The banks hold bond reserves which are more than 5% over and above the statutory minimum of 23%. These bonds are pledged to the RBI when the banks need overnight funds. The capping of this limit means the banks will now be forced to borrow at a higher rate form the RBI under the MSF.

The rate of MSF, which was 1% over the Repo rate of 7.25% have now been hiked to 10.25%. The banks, which had so far not touched the MSF, will now have no option but to borrow at higher rates.

The hike in MSF is clearly to make the cost of carry over dollar more expensive. This is an indirect measure to boost the rupee as speculators will have to shell out higher rates for their speculation.

One line message to the markets: Rates are headed higher

Also the following is likely to happen

1.   Rupee will strengthen

2.   This could in fact later on go on to support the market

3.   Bonds Yields will harden

4.   Markets will take a hit in the morning

5.   The PSU Banks could suffer again. Interest sensitives will across the board take a hit

6.   Corporate profitability will fall

7.   Earnings could be pruned down