MD, feels that the market is factoring more liquidity tightening and it may see 10-yr yield at 10%.
The Reserve Bank of Inidia or, the RBI will raise rates till growth slows, inflation is tamed, said Kumar.
Speaking to CNBC-TV18 Kumar said, the money supply will suddenly go down dramatically.
He anticipates another 50 bps rate hike and the RBI is likely to opt for repo rate hike in July policy meet.
Excerpts from CNBC-TV18's exclusive interview with Naval Bir Kumar:
Q: What do you think is the bond market pricing in with the current benchmark yield?
A: It's clearly pricing in some more rate hikes, what the Indian economy will see is some more liquidity tightening. Last time around, the governor spoke about money supply being at 21% - well above the targeted rate. So they are anticipating a de-leveraging of the economy because given the way the level of wage inflation that the economy has seen over the last 5 years and to some extent, the wage inflation continues - the higher prices aren't resulting in a major slowdown in demand like you are seeing in the western economies. The Central Bank will be forced to continue to raise the rates till that feeds into demand and hence actually brings a little slower growth to the economy in an attempt to tame inflation. So the market is factoring that and you have now started hearing voices in the street talking about 10% on the 10-year yield for July and that is a possibility.
Q: Because of the way the yields are moving, what do you think they are pricing in by the way of rate action? How much do you think the RBI might move in this policy and how much by the time we are done by with this year?
A: It's more than just rate hikes, it's more in terms of liquidity, in terms of money supply because what we are seeing is the reserve money in the system coming down and that will have an acetated effect on money supply in 6-9 months. So we are looking at money supply, which grew at about 20-plus percent levels over the last two-four years, suddenly gone down dramatically and that is what concerns the system much more. Having said that, we do anticipate at least another 50 basis point of rate hike which may not happen in one shot but may happen in two 25 basis point hikes, given the level of inflation and given the fact that inflation seems to look above in double digits for most of the current calendar year. So there will be tightening on the shorter end of the curve but it plays on the longer end of the curve simply because of the tightening money supply.
Q: What do you think Dr Reddy will do in end of July what is your sense both small repo and the Cash Reserve Ratio (CRR) hike or he will only do CRR and not repo. What do you think?
A: To do a repo and the CRR would be dependent only on money supply. So CRR is not from a rate perspective but more of money supply and over the last few weeks, the Reserve Bank of India (RBI) has had to defend the exchange rate and not allow the rupee to depreciate too much and that anyway sucks money out. So if money in the system remains tight, I don’t see him doing another CRR. If he does in a tight money situation, then obviously inflation worries are much bigger than what we all anticipate.
Q: You mentioned 10% on the benchmark, is that your sense of where it is headed in and how much do you think dues would ease off by because this 9% mark has come with quite a bit of comfort for the bond market and do you expect it to ease off considerably?
A: Not in the near future because if you take the swap rates, they have been inflated for quite some time and the only yield that hadn't moved up in the entire economy was the July yield curve and that finally reacted and so far everybody felt that banks would be big buyers because of their SLR requirements and would keep the yields depressed. But that logic holds only for a certain level and with the rest of the entire yield curve right across moving up, there was no reason for the July yield curve to remain where it was. In a tightening economy with high inflation, you had completely no spread on the yield curve. So you had overnight at 8.5% and 10-year GOIs (Government of India bonds) trading below 9%. So you had a really flat-yield curve in a situation where you are moving into a tight monetary condition, so that wasn't logical.
Q: What implication does it have for the equity market if indeed we get to somewhere close to 10% on the benchmark yield, what happens to valuations, rate sensitive etc in the equity system?
A: The equity markets will be impacted like they are because you are now in the de-leveraging environment and banks are going to find it harder and harder to raise capital. Bank share prices today indicate that the market believes there is significant credit losses in bank balance sheets because a lot of banks are trading below one time book as of now and in a de-leveraging environment, banks will reallocate capital to some extent amongst the various lending sectors. But you will see a slowdown in the economy and that will feed through right across all sectors other than may be a few which are not that rate sensitive or do not require large amount of capital.
Q: Some of the PSU banks were quite blasé about what's happening on their bond portfolio side, they felt that they would be insulated from any big move but if indeed the yields are to move this high, would there be a problem on the bond portfolio side for the PSU banks?
A: On a valuation perspective and on an MTM basis, there will be an impact. Most people, did not believe that the yield curve would move up from the GOI side. So the reactions you have got most of last week were based on that and if you continue to see upward pressures on GOI yields, the reactions could change - that you are indicating, but my big concern from an economic perspective is a de-leveraging environment and we have always seen whenever economies are de-leveraged, it's hit asset prices quite significantly. But credit squeeze is not good for asset prices and that's unfortunately what we are getting into right now.
Q: What kind of returns can one expect, given the kind of yield movement we have seen from the FMPs now and also from the regular bond funds, fixed income funds?
A: The Fixed Maturity Plans or, the FMPs in your liquid funds should give you returns between 8.5-11%, depending on where the short-end yields are and there could be spikes in short-end yields whenever you have an action by the RBI. In terms of bond fund yields, we are still advising investors to stay out of the long-term bond funds because we don't believe that the upmove in
yields is over; this is not the time still to start taking positions in the long end of the curve, unless you want to do it from a very short-term trading perspective. But from a long-term retail investor holding strategy, we are still advising liquidity and FMPs - it is very hard to outperform a 10.5% rate by being a trader and try to trade between cash and yields in a rising interest rate environment that we are in right now.
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