Normalization of Liquidity May Be Gradualistic

The level of inflation has gone beyond the threshold set by the RBI, CPI is above 6%, and that is a reason for concern. The moderation in the price level is dependent on various endogenous and exogenous factors, and prominent among these factors are the price of Brent in the international markets, and the level of the US$/Re exchange rate. The Rupee is much weaker today than it was a month ago. The pressure from higher commodity prices too is at the background. All these would add up to higher price level which may be sustained for a few months.

While growth is happening, it is only natural that some inflation too would creep in, but what we are witnessing is a more challenging situation on the price level. The stance of the monetary authorities not only in India but also abroad has been that the rising prices is transitory, and that it may even out to lower levels over time. If the expectations of the policy makers comes true then it is good for the markets, but the innate feeling that the conditions may be much worse gives rise to some amount of consternation. The last RBI policy announcement and the minutes of the MPC meeting presents a well- studied approach which gives precedence to growth over inflation. The RBI has also reaffirmed its commitment to the accommodative stance and liquidity support. It is also important to note that in case of a further build up in inflationary pressures there may be normalization especially on the liquidity front much earlier than expected.

The GSAP 1.0 provided some support to the government borrowing programme, the GSAP 2.0 too may try to achieve some amount of stability though the markets may go their way at the end of the day. Interestingly, the ten-year benchmark has moved up to 6.18 % after languishing at around the 6.00 % level for quite a long while. It may likely test lower levels back again but the pressure on yields at the long end will continue to be there due to the large issues in the primary market and this is going to accelerate as we progress towards the current quarter end by which the government is likely to complete 70 % of the total borrowing program.

The GST collections are also lower as seen from the collections for the last month, and this may revive the discussion on the need for higher borrowings later this year. Much would depend on the spread and intensity of monsoon, and the opening up of businesses post the second wave of the pandemic. These are factors that may lend a greater amount of buoyancy to the tax collections. But as indicated earlier too growth will remain the overriding consideration as far as the monetary policy is concerned. The view that we have shared time and gain is that the short end of the curve makes better investment sense and the long end should be avoided. Short term products and short-term funds should be the preference at this juncture. Further, credit risk still remains a factor to be vigilant about and portfolios with AAA rated papers to the tune of at least 80 to 85 % may be invested into.


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