Is the latest RBI policy suggesting that interest rates will start going up?
I think yes! Let me explain in the below 🧵 which is going to be your crash course on how RBI manages liquidity.
Do ‘re-tweet’ & help us educate more investors (1/n)
#Investing #StockMarket
I think yes! Let me explain in the below 🧵 which is going to be your crash course on how RBI manages liquidity.
Do ‘re-tweet’ & help us educate more investors (1/n)
#Investing #StockMarket
(Q) What’s the background?
In situations like COVID & others where there can be a challenge to businesses, job losses etc., the government through the central bank tries to maintain high liquidity in the system. (2/n)
In situations like COVID & others where there can be a challenge to businesses, job losses etc., the government through the central bank tries to maintain high liquidity in the system. (2/n)
(Q) High liquidity means?
Keep rates low to encourage businesses & individuals to borrow & invest so that job losses r reduced & demand for goods can be maintained. Ex-If rates are low, RE developers can borrow cheap & build more + buyers can borrow cheap & buy more houses (3/n)
Keep rates low to encourage businesses & individuals to borrow & invest so that job losses r reduced & demand for goods can be maintained. Ex-If rates are low, RE developers can borrow cheap & build more + buyers can borrow cheap & buy more houses (3/n)
(Q) How are rates kept low?
Rates are kept low by managing,
- Repo & Reverse Repo Rates
- Buying Bonds from the market (also known as GSAP or OMO)
- Operation twist
Let me explain, (4/n)
Rates are kept low by managing,
- Repo & Reverse Repo Rates
- Buying Bonds from the market (also known as GSAP or OMO)
- Operation twist
Let me explain, (4/n)
(Q) Explain Repo & Reverse Repo rates
Repo rate is the rate at which commercial banks borrow money from RBI for over night. So when banks borrow from RBI for 1 night, banks pay 4% per annum equivalent rate for one day called Repo Rate (5/n)
Repo rate is the rate at which commercial banks borrow money from RBI for over night. So when banks borrow from RBI for 1 night, banks pay 4% per annum equivalent rate for one day called Repo Rate (5/n)
Reverse repo is the rate at which commercial banks lend to RBI for over night. So when banks lend to RBI for 1 night, banks receive 3.35% per annum equivalent rate for one night of lending from RBI called the reverse repo rate (6/n)
While this is not completely practical, imagine this, if RBI 🔽 Repo, banks get money cheaper & hence can lend cheaper. So if the original rate was 5% of repo, the lending by banks to others happened @ 5%+ something & now that RBI has 🔽 the repo, lending happens @ 4% + something
Similarly when RBI 🔽 the reverse repo rate from lets say 4% to 3.35% it disincentives banks to lend to RBI because banks were earlier getting 4% to lend to RBI & now will get only 3.35% and hence they 'might' use that to increase lending to businesses & individuals (7/n)
So if RBI wants to increase liquidity and/or incentivize banks to lend, RBI will reduce repo & reverse repo rates & thats what you call as increasing liquidity in the system as well (8/n)
(Q) To increase liquidity, RBI also does Bond buying (OMO) / GSAP or Quantitative Easing like popularly called in the western world. GSAP is government security acquisition program, let me explain, (9/n)
Indian government like most other governments runs a fiscal deficit. Income is less than expense. So if income is 100 & expense is 105, the 5 rupees is borrowed & a bond is issued vs that promising a fixed return for a fixed time like in an FD (10/n)
When RBI wants to ⬆️ liquidity in the market, RBI buys back the bonds issued earlier for fiscal deficit before its maturity. So when RBI buys back the bonds, it has to pay the banks & that’s how liquidity is infused in the banking system. Banks have more liquidity now (11/n)
(Q) What happens when so much of Liquidity is infused in the system?
Rates across time frame falls as there is more supply of money in the system. From borrowing over night to borrowing for 10 years, all fall. This can be discomforting for RBI after a point in time (12/n)
Rates across time frame falls as there is more supply of money in the system. From borrowing over night to borrowing for 10 years, all fall. This can be discomforting for RBI after a point in time (12/n)
(Q) Why would RBI have a problem?
Assume reverse repo (rate at which RBI borrows from the banks) to be at 3.35% & imagine other market rates to be so low that Reliance can borrow for 3 months at a rate lower than RBI @ 2.75%, weird right? (13/n)
Assume reverse repo (rate at which RBI borrows from the banks) to be at 3.35% & imagine other market rates to be so low that Reliance can borrow for 3 months at a rate lower than RBI @ 2.75%, weird right? (13/n)
(Q) U might ask how is it possible?
Imagine banks flooded with liquidity & RBI nt willing 2 take money 4m the banks under reverse repo (as RBI wants to keep liquidity in the system), what will banks do keeping it with themselves? They start lending 2 large entities at lower cost
Imagine banks flooded with liquidity & RBI nt willing 2 take money 4m the banks under reverse repo (as RBI wants to keep liquidity in the system), what will banks do keeping it with themselves? They start lending 2 large entities at lower cost
(Q) What does RBI do now? It does not want to increase rates & also manage the above situation.
(Ans) Operations twist (15/n)
(Ans) Operations twist (15/n)
(Q) What’s Operation Twist?
RBI wants to increase rates at the short end (less than 1 year lending) but does not want to increase at the higher end (10 years). So they sell more bonds (issue new bonds) at the short end & keep buying bonds (GSAP) at the longer end (16/n)
RBI wants to increase rates at the short end (less than 1 year lending) but does not want to increase at the higher end (10 years). So they sell more bonds (issue new bonds) at the short end & keep buying bonds (GSAP) at the longer end (16/n)
(Q) How does this help?
Bond price & yields are inversely related. When bond price goes up, yield falls & when bond price falls, yields go up.
More on this if you don’t know the concept (do come back after reading ☺) - (17/n)
Bond price & yields are inversely related. When bond price goes up, yield falls & when bond price falls, yields go up.
More on this if you don’t know the concept (do come back after reading ☺) - (17/n)
When RBI buys bonds (GSAP) in huge volumes at the longer end, there is demand for bonds & hence price goes up & yield falls. When RBI sells bonds (issues new bonds) at the lower end, they is supply of bonds, bonds fall in value & yields go up (18/n)
By this, shorter end rates/yields increases & long end is managed (does not increase much), this is operations twist (19/n)
(Q) What’s happening now?
- RBI has stopped operations twist
- RBI in the bi-monthly policy also said they will stop the GSAP
- It also proposed to conduct 14 days long term variable reverse repo (20/n)
- RBI has stopped operations twist
- RBI in the bi-monthly policy also said they will stop the GSAP
- It also proposed to conduct 14 days long term variable reverse repo (20/n)
a) If RBI stops GSAP/twist, demand for bonds at the longer end will reduce & hence yield will go up. Its up by 0.20% already
b) If RBI starts accepting liquidity under reverse repo (it limited earlier, Reliance example) that too variable, banks will lend more to RBI (21/n)
b) If RBI starts accepting liquidity under reverse repo (it limited earlier, Reliance example) that too variable, banks will lend more to RBI (21/n)
(Q) Variable reverse repo?
Unlike over night reverse repo @ 3.35%, RBI announced that it will take money 4m banks for 14 days & the rate will be decided by an auction (variable rate). FYI, in auction, instead of 3.35%, the money was lent by banks to RBI at close to 4%. (22/n)
Unlike over night reverse repo @ 3.35%, RBI announced that it will take money 4m banks for 14 days & the rate will be decided by an auction (variable rate). FYI, in auction, instead of 3.35%, the money was lent by banks to RBI at close to 4%. (22/n)
Both are signs that RBI is now comfortable with rates going up and liquidity falling in the system in my opinion (23/n)
This will further get confirmed when the spread between Repo & Reverse Repo which currently is at 0.65% (4% - 3.35%) will come down to 0.50% (4% - 3.5%) when reverse repo rate will be increased from 3.35% to 3.5% in the worst case or even higher (24/n)
(Q) So what should investors do now?
Will write about how to invest in such times across equity, debt & gold in my next thread. Follow me if you don’t at @KirtanShahCFP (25/n)
Will write about how to invest in such times across equity, debt & gold in my next thread. Follow me if you don’t at @KirtanShahCFP (25/n)
Also if you are an advisor/mutual fund distributor or a DIY investor, we run a very detailed program on debt investing.
You can view the same here - fpa.edu.in (26/n)
You can view the same here - fpa.edu.in (26/n)
This is my 45th thread, 'do re-tweet'
Have earlier written on,
-Sector Analysis - Banking, Paints, Logistic, REIT, InvIT, Sugar, Steel
-Macro
-Debt Markets
-Equity
-Gold
-Personal Finance etc. You can find them all in the link below (END)
Have earlier written on,
-Sector Analysis - Banking, Paints, Logistic, REIT, InvIT, Sugar, Steel
-Macro
-Debt Markets
-Equity
-Gold
-Personal Finance etc. You can find them all in the link below (END)
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