RBI’s monetary policy has ‘asymmetric transmission’ in financial markets: SBI

Monetary policy has "asymmetric transmission" in Indian financial markets, and the future conduct of monetary policy may look into this aspect, which means the monetary policy signalling is now dictated more by "fuzzy market peculiarities", State Bank of India's economic research wing SBI Research reveals in recent Ecowrap note.

While the transmission from a rate change is generally "instantaneous" in the money market, it is not so in the bank lending and the G-sec market given the market "idiosyncrasies", the report says.

The report tries to find out if, over a sufficiently long period of the RBI rate cycle, the resultant transmission in the money market, bank credit market, and G-sec market moves in the same direction: i.e. a rate hike or cut begets a tighter or lower money market rates.

"Our starting point of analysis is the spread between AAA corporate bond and 10-year risk-free G-sec rates, which was around 120 bps during March/April 2020 but has declined significantly since then."

The data shows the trend has continued even as the rate cycle changed direction since April’2022 and is now significantly less than half of the average spread at the pre-pandemic level i.e. in FY20. This indicates, says the report, that the risk pricing of the paper, which was lower during low demand and high liquidity has not moved up commensurately even though the credit demand has picked up and liquidity dried up, reflecting inadequate risk premium.

Does this reflect a newfound peculiarity of asymmetric transmission from monetary policy to rate transmission in Indian money markets, G-sec market, and even bank credit market, asks the report.

The results show that a 1% increase in repo rate has resulted in only a 2 to 3 bps increase in the 10-year AAA corporate bond spread and, a 3 to 4 bps increase in 5 year AAA corporate bond spread, but there has been around 31 bps decrease in spread of 3 year AAA corporate bond. This signifies that 3-year AAA corporate bonds are not priced with adequate risk premium and they could have been at least be priced at a 26-43 bp higher rate.

A 1% increase in repo rate increases CP weighted yield by 120 bp increase for up to 31-day tenor, by 147 basis points in 31 days to 91 days, 178 basis points in 92 days to 180 days, and surprisingly lower at 151% in 181 days to 365 days tenor. "Our further estimates suggest that 180-365 days CPs are priced exuberantly and are underpriced by up to 90 bps," the report suggests.

As far as bank credit is concerned, market sources pointing to short-tenor working capital loans of less than one year are given even with finer rates in the range of 7-7.5% or even less. Notably, the 10-Yr G Sec is currently trading at around 7.18%, while 91 Day T Bill is at around 6.85% and 182 Day T Bill is at around 7.04%.

The pricing for a corporate paper should generally be higher by at least 50-100 bps, to cover the risk premium, over government paper depending upon the rating, tenor, etc, the report adds.