Expected 75 bps cumulative repo rate hike in current cycle: SBI Ecowrap
Ten-year benchmark yields could reach 7.75 per cent by September
State Bank of India’s Economic Research Division (ERD) expects a 25 basis point (bps) repo rate hike in June and August each, with a possible 75 basis point cumulative increase in the current cycle and government securities (G-seconds). Yields will reach 7.75 per cent by September.
The repo rate (the interest rate at which banks borrow from the Reserve Bank of India to overcome short-term liquidity imbalances) is currently 4 per cent. A base point equals 0.01 percent.
Referring to the fact that retail inflation rose to 6.95 per cent year-on-year in March 2022 from 6.07 per cent in February, mainly on food price inflation, inflation prints are likely to remain above 7 per cent until September, according to a report by the ERD. .
“After September, inflation prints may be between 6.5 per cent and 7 per cent. According to the ERD estimate, our FY23 inflation estimate is now approaching 6.5 percent.
According to ERD’s Ecowrap report, historically, at the lowest end of the spectrum, the spread between repo and G-seconds is approximately 250 basis points (bps). During the interest rate hardening cycle, spreadsheets can be as high as 350 bps.
“The 10-year benchmark yield should reach 7.50 per cent even with the current repo rate of 4 per cent.
“In the cycle of rising interest rate spread between G-sec yields and repo rate, G-sec yields could reach 7.75 per cent by September,” said SBI Group Chief Economic Adviser Soumya Kanti Ghosh. Currently, the 10-year benchmark yield is around 7.24%.
The ERD team believes that the RBI will limit G-sec returns to 7.5 per cent through unconventional policy measures.
The report said that the rise in current yields was linked to the RBI circular on Friday.
In principle, in order to make the Standing Deposit Facility (SDF) attractive and bring it in line with the reverse repo facility for SLR (Statutory Liquidity Ratio) management, the RBI has made deposits parked under SDF a eligible asset.
Therefore, from the banks’ point of view, the SDF facility provides high returns without compromising on legal ratio management and low risk exposure (counterparty is the central bank).
“As funds parked under SDF are eligible to be counted for SLR, we do not intend to introduce this facility in a way that could lead to any growing demand for SLR securities.
“If the RBI does not impose a limit, it indicates a yield on unallocated territory. As expected, technically speaking, a move of 7.5 per cent and above for G-second yields would be faster and faster than we currently see, ”Ghosh said.
Rising rates: Effects on the environment causing instability
The report emphasizes that the recent spike in benchmark yields indicates a disconnect and the difference between benchmark yields and bank lending rates, with banks moving into new territory where lending rates are now effectively lower than yields, thereby reducing risky lending.
Also, as benchmark rates begin to rise, effective yields may increase further, ensuring demand de-growth from corporates for the proposed kopecks (capital expenditure).
“The effects on the economy are volatile, as banks are forced to raise lending rates and have to align themselves with a market-determined course (NBFCs follow the mark-up).
“The good news is that new investment announcements have grown significantly by about Rs 10 lakh crore in the last two years, to a record high of Rs 19 lakh crore in FY22,” Ghosh said.
April 13, 2022