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RBI bonanza sets stage for lower bond yields

  • The central bank’s move may result in lower interest rates for retail loans
  • The government should use the RBI fund transfer to bridge the shortfall in revenues, say analysts

The Reserve Bank of India’s decision to transfer 1.76 trillion to the government has seen mixed reactions from economists and market experts. The move is expected to ease the revenue shortfall that the government faces and help fill the fiscal deficit gap. “It alleviates the risk of widespread fiscal slippage," said Shubhada Rao, chief economist at Yes Bank Ltd, echoing the sentiments of most market participants.

The transfer includes a surplus of 1.23 trillion for FY19, of which 28,000 crore has already been transferred to the government; the balance will be transferred in this financial year. An additional amount of 52,637 crore from the contingency reserve maintained by RBI is also being transferred to the government.

We explore the implications of this move and how it will translate into outcomes, if any, for retail investors. The government had already accounted for a dividend of 90,000 crore from RBI in the budget presented in July 2019. The marginally higher dividend received is positive for government finances. The excess capital of 52,637 crore returned to the government is the additional amount that will now be available to the government which will, to a large extent, bridge the revenue gap that was seen in the budget.

The transfer is also expected to add to the surplus liquidity in the system. “The government is currently running a Ways and Means Advance of around 1 trillion against the expected fund transfer from RBI. The net liquidity situation which is already in surplus changes only by around 50,000 crore because of this transfer," said Arvind Chari, head, fixed income and alternatives, Quantum Advisors Pvt. Ltd. The excess liquidity, along with the additional rate cut expected from RBI will keep yields low in the short-term money markets and investors are likely to see subdued returns on their money parked in this space. “The longer end of the yield curve, 10-year and above, is pricing in the possibility that the government may increase fiscal deficit by providing an economic stimulus, though the government has rightfully stayed away from doing it so far. If additional funds are used to bridge revenue gaps, it may give comfort to the bond markets and long-tenor yields will also come down," said Chari. Investors in long-term bonds and bond funds will see some tactical gains.

The ability of the government to give adequate stimulus to a flagging economy has been hindered by its tight fiscal situation. But with this windfall, there may be greater expectation from equity markets. “The government will have some flexibility in front-loading some consumption expenditure and, therefore, growth," said Rao. “The money in the hands of the government has improved its ability to push cash transfers and other measures for the rural economy, which will bring back consumption."

Equity markets will take heart from the stability that comes to the fiscal situation even if there are no direct benefits in the form of economic stimulus offered by the government. “The equity market will wait for some visibility of how the government expects to use these funds before reacting to it," said Deepak Shenoy, CEO and founder, CapitalMind Wealth. “While managing the fiscal situation is of primary importance, the government cannot avoid providing some relief to the sluggish economy," he added.

Shyam Sekhar, chief ideator and founder, iThought, too does not see the government resort to measures to boost consumption even though they now have greater fiscal manoeuvrability. “I don’t see the government taking any measure that will be fiscally imprudent. The government’s focus on infrastructure spending will continue and that will give a fillip to the investment cycle," he said.

Borrowers may see some benefits too. “Since liquidity is in surplus, you will see lending rates being cut by banks as the weighted average cost of incremental borrowings come down. You may also see another round of rate cuts by RBI if inflation stays below the target level," said Chari. “Lowering of rates of interest on personal consumption loans is indicated," said Rao. “With RBI’s policy stance shifting to accommodative since June 2019, the positive liquidity situation will imply better transmission of lower rates to borrowers," she added.

The move is unlikely to stoke inflationary pressures in the economy either on account of the monetization of the reserves or from the stimulus that the government may provide to the economy. While there will be some improvement in consumption expenditure from the government, I don’t think it will fuel inflation," said Rao. “The amount is not significant from a monetization point in the current economic condition and given the size of RBI’s balance sheet. If it had been 2-3 lakh crore it would have been worrisome from an inflation point of view," said Chari.

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