Ananth Narayan of Standard Chartered Bank says that the fiscal-deficit target of 4.8 percent for FY14 is tough to achieve and expect yields to stabilise at current levels. Narayan adds that OMOs and a potential rate-cut in March may support bonds. He expects 10-year yields at 7.8 percent by March-end. "I see rupee hovering in 53-56/USD range with support from divestment-related," he told CNBC-TV18.
Below is an edited transcript of the analysis on CNBC-TV18
Q: What did you make of the Budget and why have yields hardened after the Budget?
A: There are a couple of reasons. One, a lot of the good news has already been factored in by the bond markets thanks to roadshows by the finance minister a month before the Budget promising a fiscal deficit of 4.8 percent for the next year.
What has made the markets a bit nervous was the ability to achieve that fiscal-deficit target which requires a lot of revenue generation given that expenses really haven't been curtailed. The size of the gross borrowing programme which factors in some buybacks of short-end bonds maturing in 2015 which needs to be replaced by longer duration bonds which will in effect supply net duration into the market was really a cause for some nervousness in the market.
However, the market should stabilise at current levels maybe even recover. There is no supply coming through in March and there should be a few open market operations (OMOs) to ease liquidity. FII demand could rebound and there is increased expectation of a rate cut coming up in the next policy. So, ten-year bonds will still gravitate towards 7.8 percent in the short-run till March.
Q: Is there is enough clarity on that borrowing estimate?
A: I guess some clarity has emerged. The borrowing isn’t lower and while the government is clarifying that some of it is a buyback - a reverse ‘Operation Twist’ where the Reserve Bank of India (RBI) will be buying back short-term bonds and supplying fresh longer-term bonds. In reality this will have a negative effect on bonds with one set of bonds pumping duration into the market.
The only positive is the RBI projecting the same amount of cash to remain in the next fiscal as well and chances are that it will start a huge amount of cash. So, maybe it will have room to reduce the borrowing programme in the next year. At the moment, the short-run will be positive for bonds till March and when the next credit policy necessitates a fresh outlook for the borrowing programme next fiscal.
Q: Has it been a bit of a curve ball for investors trying to gauge what the bond market would do because before the Budget there were expectations of 7.5-percent yield and now 7.85-7.95 percent is probably a more reasonable target?
A: That is always a risk. Before the Budget, the debate was whether the yield would be 7.75 or 7.5 percent and that frankly is never a good sign for the market. It is an indication of the market being on one side. However, some of that pressure has eased over the last few days and OMOs have taken out some bonds from the market. Public sector banks have been buying bonds in aggressively over the last three-to-four days. All this should ease some of the positioning strain in the market
I expect the yields to come down to about 7.8 percent in March. The next fiscal is going to be a whole new ballgame altogether.
Q: What do you make of the way the rupee traded last week? What kind of markers are being set, will it go beyond 55?
A: Yes. With the rupee closer to 56 and a base case of 53-56, there is going to be an upside due to the fundamental negatives in the market. However, some of the positives are the level of forward premier which is at an all-time high indicating that the market is far better prepared for depreciation in the rupee now than it was ever before. Exports should be better compared to the last fiscal. With US private sector growth reviving, some of India’s engineering exports should be a lot better.
The rupee has depreciated against other Asian peers in a significant manner in the last three-to-four years and in March there should be some anecdotal FDI and FII flows as divestment goes through and as the FII quotas get filled up.
So it is because of these positives I still stick to the 53-56 range. The biggest negative factors are the midcap sector and the wobbly infrastructure sector which questions the entire growth potential of India and the prospects for the rupee as well.