'Low repo rate indicates stable forex mart'

NetScribes/Janaki Krishnan

Two things happened on Wednesday that opened up speculations about the future trend in the money markets.

The Reserve Bank of India cut the repo rate by 0.50 per cent, signalling lower interest rates and a restoration of normalcy in the forex, money and debt markets.

An hour later, results of the auction of 8-year government paper were announced; it had devolved to the extent of 92 per cent on the RBI and the primary dealers! With call money rates at 14-15 per cent, banks and other money market players had refused to absorb 8-year paper at 11.40 per cent.

RBI's decision to lower the 6-day repo rate is being viewed as a move by the central bank to restore the shape of the yield curve. At present, the yield curve is inverted with shorter-term rates higher than long-term rates. According to Royappa, managing director, SBI Gilts, and chairman of the Primary Dealers Association of India, the lower repo rate is actually recognition of the stability in the forex markets.

While he refused to call it a trend, Royappa said that it had to be seen in a larger perspective. The lowering of interest rates means that the yields on government paper would be lower. This will reduce costs for the government in its borrowing programme, "which is good from the point of view of the economy," he said.

Explaining the reason for the devolvement of the 8-year paper, Royappa said that the money market was giving returns as high as 14-15 per cent, so "why should banks invest in something which gives them around 11.5 per cent". He pointed out that investors have been putting in money into repos at high rates as the relative returns were higher in the money market.

It made sense for investors to pick up paper only when the returns justify the high investments made. Dealers said that the current devolvement would make no difference as in another two weeks the RBI would be able to push through the paper and raise the required amount. "This is what past experience shows," they said.

Royappa admitted that the glut of government paper in the market and the lack of takers for them were all temporary occurrences which would be ironed out once the yield curve regained its normal upward tending arc instead of the current inversion it was showing. "Once the market for long-dated paper picks up, there'll be more liquidity in the system," he said, pointing out that this segment of the market was virtually seeing no action.

The reduction in the repo rates was reflected in an immediate fall in the call rates, while the prices of securities moved up by 10 to 15 paise after the repo auction.

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