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Pranam,

RBI announces extreme measures to curb exchange rate depreciation; Markets to react adversely

Reserve Bank of India released the following statement on measures to address rupee swings on website.

** Marginal standing facility (MSF) recalibrated with immediate effect to 10.25%, 300 basis points (bps) above the current policy repo rate – This compares with the current MSF rate of 8.25% or 100 bps above policy rate.

** Bank rate adjusted to 10.25% with immediate effect – This will raise the cost of Export re-finance by 200bps with immediate effect.

** Change in liquidity adjustment facility (LAF) to 1% of NDTL vs no limit now; to come into effect from July 17 – 1% of NDTL is ~ INR 750 Bn and compares with LAF borrowings of ~INR 900 Bn by banks today. Marginal cost of borrowing by banking system for short term liquidity will rise by 300 bps as banks will be forced to resort to borrowing from MSF window.

** RBI to conduct open-market sales of government bonds of 120b rupees on July 18. Details of securities in OMO sale auction to be given tomorrow – System liquidity was already severely strained and RBI had been conducting OMOs to ease liquidity. The latest announcement marks a

U-turn in RBI actions with system liquidity expected to worsen.

The above measures will have an adverse impact on Indian equities.

RBI hikes MSF/Bank Rate by 2%; limits LAF support to INR750b; initiates OMO sale of INR120b; negative for rates, growth

- RBI hiked the MSF/Bank Rate by 2% to 10.25% with immediate effect implying a corridor of 300bp from the policy (Repo) rate of 7.25%.

- Simultaneously, it placed a ceiling on LAF support to 1% of NDTL (operationally at INR750b) effective July 17, 2013 onwards.

- It also announced OMO sale of INR120b on July 18, 2013.

- The move ostensibly done to correct INR is likely to result in immediate flare up of the short terms rates including call money for which the MSF rate now would be the operative rate.

- Liquidity deficit would widen too after the temporary reprieve on Government spending its cash balances. The long term rates too are likely to increase for the combined impact of increase in short term rates, OMO sales and strained liquidity. Repo rate hike in July 30, 2013 measure in not ruled out to align the policy rates to market reality. Interest rates spreads are likely to widen.

- Banks may have to resort to part liquidation of SLR to tide over the liquidity situation. Further they may be compelled to increase the base rate too.

- GDP growth will take a knock on the above measure too. At the other end, delay in recovery of investment cycle, slowdown in bank credit or even correction in real estate prices may be triggered.

- RBI's measures are based on the following two assumptions; i) lower INR availability would improve exchange rates and ii) a reopening of the arbitrage opportunities between foreign and domestic debt adjusted for currency risk would entice FIIs debt holders back to India.

- However, global liquidity flows and relative growth performance may impact currency more than purely domestic availability of money. At the outset one might argue that INR at 60/USD are somewhat lower than their par value in REER terms and would have served to correct the trade and current account gap. The current measures therefore are more short term in nature to tide over the funding gap and INR volatility.

RBI tightens money to appreciate INR

- MSF/Bank Rate hiked by 200bp: RBI hiked the Marginal Standing Facility (MSF) and Bank Rate from the current 8.25% to 10.25%; i.e., by 200bp with immediate effect. Accordingly, the MSF corridor that maintained a gap of 100bp over the key policy rate, i.e., Repo rate now stands expanded by 300bp.

- LAF will be limited to 1% of NDTL, i.e., INR750b: RBI placed a cap on LAF borrowing to 1% of NDTL (reckoned at INR750b for this purpose) effective July 17, 2013. The allocation to individual banks will be made in proportion to their bids, subject to the overall ceiling.

- OMO sale of INR120b on July 18: RBI would resort to Open Market Sales of Government of India Securities of INR120b on July 18, 2013.

- Backdrop of INR fall on FIIs debt outflow: The measures have been taken in backdrop of FIIs debt outflow on expectations of reduced QE by US FED that led to INR depreciation. The INR fall "evidences that the demand for foreign currency has increased vis-a-vis that of the Rupee in part because of the improving domestic liquidity situation".

Odds increase for a 25bp cut in Jul-13 policy now Already strained liquidity may come under further pressure

Takeaways – negative impact on liquidity, rates, growth; elusive gains on INR

- Immediate impact on interest rates: The combined impact of rate hike for additional borrowing and for export refinancing combined with restrictions on liquidity support would immediately hike the short term interest rates including call money immediately by 300bp. This is because LAF deficit already touched INR923b on July 15, 2013 and restriction of LAF support to INR750b would force banks to resort to the MSF window. Hence MSF at 10.25% would become the new operative rate for call money in place of repo rate at 7.25%.

- Liquidity deficit to widen: Contrary to expectations, RBI would now resort to OMO sales to constrain liquidity in place of OMO purchases of the last three years to infuse liquidity. This would widen the liquidity gap further that exceeded 1% of NDTL by last count. Also we are well past the temporary reprieve of lower LAF deficit on the back of government spending of INR1.3t and the liquidity gap was expected to re-open shortly.

- Increase in long-term rates: Along with the short term rates, the long term rates too are likely to shoot up. This is because the cost of marginal borrowing have gone up for the banks. This would exert an upward pressure on base rate too. The hike in longer term 'Bank rate' of RBI would exert pressure on export refinancing discouraging exports.

- Repo rate hike not ruled out: As the market rate of interests itself would go up this would mean that RBI may align the current policy rates upwards to the prevailing higher interest rates across other market segments. Indeed the measures can be taken a prelude to an eventual shift in the monetary policy stance to a less accommodative one.

- Spreads to widen: The prevailing spread between government bonds of different maturity may widen as also the credit spread between government and corporate bonds.

- SLR liquidation is likely: To tide over the expanded liquidity gap and also for the success of OMO sales by RBI, banks may have to resort to part liquidation of their SLR portfolio even though the scope for profitable exists have dwindled.

- Downside risks to GDP growth: As it happens further increase in interest rates and constrained liquidity is likely to act as a further drag on GDP growth. Also this may prolong recovery of investment cycle, lower bank credit growth and may even trigger a correction in real estate prices.

- Measures may be ineffective for INR too: RBI's measures are based on the following two assumptions; i) lower INR availability would improve exchange rates and ii) a reopening of the arbitrage opportunities between foreign and domestic debt adjusted for currency risk would entice FIIs debt holders back to India. However, a lower growth outlook may reduce attractiveness of India vis-à-vis others. Further the dynamics of exchange rate movement has changed fundamentally to reflect global liquidity situation and perceived current and future performance of the economy in comparison with others.

- What is wrong with INR @60: As INR retains its par value of 100 in REER terms at 58/USD, at 60/USD it would reflect some undervaluation. As India has a huge trade and current account gap a lower exchange rate is expected to slowly correct external imbalance while reducing the need for external financing. The current measures therefore are more short term in nature to tide over the funding gap and INR volatility.

Symbol	Best Bid		Best Offers		LTP	Underlying LTP	Futures LTP	Spread	Spread (%)	Open Postions	Annualised Yield (% p.a)	Volume	Turnover (lacs)	Transaction Value (lacs)	CA
Symbol	Quantity	Price	Price	Quantity	LTP	Underlying LTP	Futures LTP	Spread	Spread (%)	Open Postions	Annualised Yield (% p.a)	Volume	Turnover (lacs)	Transaction Value (lacs)	CA
ZEEL	-	-	-	-	-	241.35	241.20	0.15	0.06	-	-	-	-	-
WIPRO	2,500	0.50	-	-	-	371.25	374.70	-3.45	-0.93	15,470	0.96	-	-	-
TCS	-	-	-	-	-	1,652.90	1,645.00	7.90	0.48	-	-	-	-	-
TATACHEM	-	-	-	-	-	285.00	278.20	6.80	2.39	-	-	-	-	-
SIEMENS	-	-	-	-	-	567.40	551.20	16.20	2.86	-	-	-	-	-
SESAGOA	2,000	0.50	-	-	0.51	151.55	152.00	-0.45	-0.30	11,465	2.41	8,800	0.0449	13.8081
SBIN	1,000	2.00	-	-	-	1,821.30	1,834.40	-13.10	-0.72	782	0.79	-	-	-
RENUKA	-	-	-	-	-	18.50	18.20	0.30	1.62	-	-	-	-	-
RELIANCE	5,000	0.50	-	-	-	891.35	897.45	-6.10	-0.68	99,569	0.40	-	-	-
RCOM	40,000	0.50	1.40	400	-	144.10	143.20	0.90	0.62	100,000	7.20	-	-	-
PTC	-	-	-	-	-	46.50	45.30	1.20	2.58	-	-	-	-	-
ONGC	25,000	0.25	-	-	-	302.40	305.00	-2.60	-0.86	-	-	-	-	-
LT	-	-	-	-	-	967.25	960.15	7.10	0.73	-	-	-	-	-
KOTAKBANK	5,000	1.00	4.00	1,900	-	724.00	727.70	-3.70	-0.51	53,840	1.98	-	-	-
ITC	25,000	0.25	0.40	25,000	0.40	354.60	357.40	-2.80	-0.79	50,000	0.81	25,000	0.1000	88.2500
IOC	-	-	-	-	-	229.35	227.65	1.70	0.74	-	-	-	-	-
INFY	5,000	1.00	-	-	-	2,743.35	2,765.25	-21.90	-0.80	9,966	0.26	-	-	-
IGL	-	-	-	-	-	292.70	290.00	2.70	0.92	-	-	-	-	-
IFCI	-	-	-	-	-	25.65	25.00	0.65	2.53	-	-	-	-	-
IDBI	-	-	-	-	-	71.10	68.95	2.15	3.02	-	-	-	-	-
ICICIBANK	1,500	1.00	-	-	-	1,004.00	1,014.70	-10.70	-1.07	13,494	0.71	-	-	-
HINDUNILVR	5,000	0.50	0.90	3,000	-	615.85	621.00	-5.15	-0.84	-	-	-	-	-
HINDPETRO	-	-	-	-	-	236.05	231.90	4.15	1.76	-	-	-	-	-
HEXAWARE	-	-	-	-	-	99.00	98.60	0.40	0.40	-	-	-	-	-
HEROMOTOCO	-	-	-	-	-	1,691.00	1,661.25	29.75	1.76	-	-	-	-	-
HDIL	-	-	-	-	-	39.80	39.20	0.60	1.51	-	-	-	-	-
HDFCBANK	5,000	0.50	-	-	-	676.15	682.00	-5.85	-0.87	-	2.65	-	-	-
HDFC	1,450	0.50	-	-	0.50	813.40	821.20	-7.80	-0.96	8,300	0.44	15,250	0.0762	129.4725
HCLTECH	5,000	0.50	-	-	-	875.55	881.50	-5.95	-0.68	-	-	-	-	-
HAVELLS	5,000	2.00	-	-	-	791.20	795.00	-3.80	-0.48	-	-	-	-	-
GAIL	-	-	-	-	-	322.50	322.25	0.25	0.08	-	-	-	-	-
CHAMBLFERT	-	-	-	-	-	38.10	36.65	1.45	3.81	-	-	-	-	-
CAIRN	25,000	0.25	-	-	-	303.50	305.90	-2.40	-0.79	-	7.07	-	-	-
BHEL	5,710	1.25	1.70	200	-	181.40	180.60	0.80	0.44	92,290	5.52	-	-	-
BHARTIARTL	25,000	0.25	-	-	-	312.90	315.10	-2.20	-0.70	2,114	2.29	-	-	-
BHARATFORG	-	-	-	-	-	225.80	223.10	2.70	1.20	-	-	-	-	-
BANKBARODA	5,000	0.50	-	-	-	560.90	565.30	-4.40	-0.78	-	5.42	-	-	-
BAJAJ-AUTO	5,000	2.00	5.00	800	-	1,881.00	1,893.00	-12.00	-0.64	22,912	0.76	-	-	-
AXISBANK	5,000	1.00	-	-	-	1,242.50	1,253.50	-11.00	-0.89	3,000	5.18	-	-	-
ASIANPAINT	5,000	2.00	-	-	-	4,805.70	4,855.00	-49.30	-1.03	-	-	-	-	-
AMBUJACEM	20,000	0.50	2.00	1,900	-	197.30	195.50	1.80	0.91	-	0.07	-	-	-
ACC	-	-	-	-	-	1,248.20	1,246.00	2.20	0.18	-	-	-	-	-