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Tuesday, 10 April 2012 02:07
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FIIs cash out of bond market, testing government’s resolve
Though RBI has said the fiscal consolidation efforts of the government looked credible, the bond markets are clearly not buying this. Just last week, 7% of government bonds auctioned by RBI found no takers and devolved on the primary dealers, suggesting that markets expect yields to go up further—this happened despite RBI infusing liquidity in the market through open market operations on a regular basis. What has made matters worse, other than the bond market apprehension that the budget will not be able to meet its deficit correction targets, is that fears of the GAAR and its impact on debt market returns has got FIIs to withdraw significantly—after five months of buying debt, FIIs sold $1.5 bn of government debt in March. The fact that, with Q3 current account deficit at 4.3% of GDP, the rupee is under pressure again, and this further reduces effective returns for investors in bonds—any attempt by RBI to stabilise the rupee, and the demands will come once the rupee falls a bit more (CLSA has an end-2012 target of 55 rupees to the dollar) will add to pressure on liquidity. What makes things worse, for the first time after seven years, deposits mobilisation by banks has fallen, from R7.15 lakh crore in FY11 to R6.95 lakh crore in FY12—this is both a result of the lower levels of savings in the economy, greater purchase of instruments like gold and an increase in interest rates on postal and other savings.
In other words, RBI’s credit policy next week faces an even more serious challenge than seemed the case at the time the budget was presented. While most are hoping for a rate cut, the chances of that look a lot slimmer—while many economists were looking at a 100-125 bps rate cut in the year, most are looking at 50 bps now. Since RBI doesn’t have too much room to manoeuvre, the best that can be hoped for is, apart from a further cut (75 bps?) in the CRR, perhaps a 25 bps rate cut. The bigger issue, for now, in the mind of the markets is whether the government will read the signals clearly and make necessary changes in its budget. A rollback seems likely in the case of the eminently sensible excise duty proposal on branded jewelery; will the government roll back some of the not so sensible moves it has made on GAAR and retrospective taxation?

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