Long Term Repo Operations!

“It is important not to discount the RBI! It has to be kept in mind that the central bank has several instruments at its command that it can deploy to address the challenges that the Indian economy” - Mr. Shaktikanta Das

Majority of market participants were expecting RBI MPC’s to be a mundane event with no change in interest rates. It was believed that the persisting slowdown might force RBI to remain on dovish tone despite spike in inflation. Although, retail inflation surged to 7.35% in Dec, outside the target range, but it is largely because of volatile vegetable inflation. Moreover, given lower crude prices and negative output gap overall inflation is expected to ease in coming quarters.

Interest Rate cut without sufficient transmission?  

In current cycle of interest rate cuts, RBI has already reduced rates by 135 bps and kept liquidity sufficiently positive. The transmission of excess liquidity and cuts has been lopsided across tenure. While short term rates have responded to policy adjustments the longer term yield remained sticky. For instance, overnight rates have reduced by 146 bps and 3-month CPs of non-banking financial companies reduced by 190 bps, suggesting sufficient transmission. On the other hand, 5 year government security yield reduced by 73 bps and 10 year government security yield corrected by 76 bps. Moreover, weighted average lending rates (WALR) on outstanding rupee loan corrected by just 13 bps during Feb-19 to Dec-19.

In this background, Mr. Shaktikanta Das said:“It is important not to discount the RBI! It has to be kept in mind that the central bank has several instruments at its command that it can deploy to address the challenges that the Indian economy”. RBI announced Long Term Repo Operations (LTROs) to improve credit flow and transmission in the system. RBI will conduct LTROs of INR 1 trillion in 1 year and 3 year tenure at repo rate, i.e. 5.15%.

On prima facie LTROs will increase the durable liquidity of banking system and it should lead to better transmission. It is noteworthy that Banks can not lend funds for longer tenure using overnight excess liquidity, but additional durable liquidity should allow them to lend on longer tenure buckets. Consequently, Bond markets cheered the move with a yield curve shifting lower across the tenure.

	5-Feb (Pre Policy)	17-Feb	Change
1 Year	5.45%	5.3710%	8 Bps
3 Year	6.1100%	5.7840%	32 Bps
5 Year	6.2750%	5.9490%	32 Bps
10Year	6.5050%	6.3740%	13 Bps

As above table shows, Three and five year bonds are prime-beneficiaries of LTROs as five year G-Sec bonds rallied more than 30 bps. This has resulted to nearly 105 bps transmission against 73 bps earlier. USDINR 1 year forward premium has corrected sharply from 4.16%, pre-policy, to 3.87%. USDINR 1 year forward premium points has taken support near 8 month low of 272 points and now trading at 276.50 points.

At last, Reserve Bank of India, under Shaktikanta Das, has been proactive in using new tools (USDINR Buy/Sell Swap, Operation Twist and LTROs) for monetary transmission. Thus, it might pay dividend to remain on the side of the central bank!