The Market Tent and Subbarao's Camel

Dr Subbarao will hold its first quarter review of monetary policy on Tuesday the 30^th of July. The markets are complacent that he will hold the rates steady not rock the growth boat by hiking interest rates, as RBI has already stepped in twice to save the rupee.

The markets complacency stems from the numerous assurances given by the various men in authority that RBI’s late night action on 15^th July, when it hiked the MSF and sponged out the liquidity from the system, was not a prelude to the central bank hiking rate.

None other than FM himself gave this assurance. Since the action on the evening of July 15^th came after Chidambaram summoned Subbarao to Delhi the street cannot be faulted for showing some faith in what the FM has  said.

However, the anecdotal evidence does not point to the RBI holding its repo rate pat. The Repo rate is currently placed at 7.25%. The bond yields are hovering around 8.16%.

The recent treasury auctions saw firming up of the yields. The Government is probably harping on the hopes of a successful bond issue to tide over the current problems. Going by the recent experiences the yield is likely to be higher.

Dr Subbarao, whose two year extension comes to an end on September 4, is likely to hike rates, if he has not been offered an extension but may hold back the urge in case hints have been dropped. The reason I am saying this is because Dr Subbarao has so far stood his ground against the public utterances of the FM as to what the RBI should do. In case this is his last policy he would like to hike rates and leave his stamp. But in case it isn’t, he will have all the time and elbow room to wait and watch.

The RBI is in a classic dilemma. If it hikes rates, it can save the currency. But the high rates will surely hit growth. The FII equity investors may sell and hit the currency. So it could be back to square one.

The rising yield will also trigger mark to market losses for the banks in their bond portfolio. Banks hold around 28% of their deposits in bonds. The banks are not required to provide for any mark to mark losses on the bonds which they want to hold till their maturity(HTM) . So the banks will suffer on their Available for Sale (AFS) portfolio.

Let’s come back to our earlier point of the assurances given by the FM that these steps  ( hike in MSF and sponging out of liquidity) are temporary in nature. If these were indeed short term, of a few weeks duration, then the RBI should signal their end and give a time frame of their withdrawal. 

The RBI is unlikely to oblige.

While I  don’t know  about those living on Mars, those dwelling on the planet earth should not even think that RBI will give you a time frame. It just can afford to tell us that these  measures will be in place as long as the volatility in the Rupee remains. Now go out and decipher what this means.

I am reminded about an anecdote from the medieval times.

Incumbents of a camp complained of no room to move about in the tent to their leader. The leader assured them of help the day after if they agreed to accommodate a camel just for the night. People made way for the camel to the ushered in. The next morning the leader simply took out the camel and camp heaved a sigh of relief.

Dr Subbarao is unlikely to take the camel out in a hurry.