BofA-ML’s Jayesh Mehta Advocates Surplus Liquidity To Help Ease Interest Rates
Liquidity conditions should be surplus for transmission of lower policy rates, says Jayesh Mehta of Bank of America-Merrill Lynch
Reserve Bank of India’s Monetary Policy Committee delivered a surprise rate cut in February and shifted its stance to ‘neutral’ from ‘calibrated tightening’. Markets expect at least another 25 basis point cut in the repo rate in April, and perhaps another one after that.
Yet, long-term interest rates in the market have scarcely budged. The yield on the 2028 government bond is roughly at the same level as on Feb. 7, 2019—the date of the last monetary policy review. As a result, the spread between the RBI’s overnight repo rate and the old 10-year bond has widened to about 125 basis points.
Tight liquidity conditions have prevented the transmission of the rate cut, said Jayesh Mehta, country treasurer at Bank of America-Merrill Lynch.
When your inflation is in check and you are looking at growth, you should have surplus liquidity of Rs 60,000 crore to Rs 70,000 crore. But nowadays, the theory is that liquidity has to be negative. I don’t personally agree. I think on both sides, you should maintain liquidity in surplus or deficit depending on the stance. If you have a tightening stance, then liquidity has to be short, if its an accommodative stance, liquidity has to be surplus.Jayesh Mehta, Country Treasurer, Bank of America-Merrill Lynch.
Mehta believes the central bank is repeating a mistake it made in 2016.
Starting January 2015, the RBI began cutting rates. But despite a 125 basis point cut in rates over a little more than a year, borrowing costs in the economy had not dropped. Finally, after repeated conversations with market participants, former RBI Governor Raghuram Rajan agreed to alter the central bank’s liquidity stance towards neutral liquidity.
Mehta believes a similar change in the liquidity view is needed now. The RBI could use forex swaps, like it did this week, or bond purchases under the open market operation to ease liquidity, he said.
We have seen this in January 2015-March 2016. While we cut rates, the non-benchmark yields were actually higher because you didn’t give liquidity. So I think liquidity is very important...But as of now, the feelers we get is that they want liquidity to be negative.Jayesh Mehta, Country Treasurer, Bank of America-Merrill Lynch.
Easier liquidity conditions will also help corporate borrowers who have seen spreads over government bonds remain elevated since September.
Defaults by once AAA-rated Infrastructure Leasing and Financial Services Ltd. roiled the markets and led to higher yields for non-bank finance companies and corporates. While some amount of this is due to increased risk-aversion in the market, easier liquidity conditions will help, said Mehta.
Your G-Sec spread over repo rate is higher, naturally then your corporate spread over G-Sec will also be higher. I think both these factors are important and it comes back to liquidity....Jayesh Mehta, Country Treasurer, Bank of America-Merrill Lynch.
Central bank officials don’t necessarily agree with that view.
Companies are facing challenges in raising funds from the market because of their weak balance sheets, and not due to shortage of liquidity in the system, a Reserve Bank of India official told reporters earlier this week while requesting anonymity.
Watch the full interview here: