India may see slowdown in medium term: Deutsche Bank

Excerpts from Markets Midday on CNBC-TV18 Watch the full show » ALSO READ See what other FIIs are saying about the markets See what other experts are saying about markets See what Udayan Mukherjee is saying about the markets Nifty BSE | NSE 25/05/12 Are Mutual Funds betting on Nifty?

Ananth Narayan , Treasury Head of Deutsche Bank does not rule out a repo rate hike by the Reserve Bank of India ( RBI ). He does not rule out a slowdown in the medium-term. 

The 10-year bond yield could head higher in the medium term, Narayan said. The RBI does not have much flexibility in monetary policy and short-term yields would come off in case the RBI hikes only CRR or the Cash Reserve Ratio, he added.

Excerpts from CNBC-TV18's exclusive interview with Anant Nayaran:

Q: For the moment it is a good news, is the market improving at all because of the slightly lower than expected inflation number?

A: It is a little lower today compared to where it was in the morning. But I don't think in the medium-term we have got any respite as such. Clearly, the events over the past week have thrown up fresh numbers, which are fairly worrisome. You mentioned inflation just now. Just as worrying is the fiscal side, where the numbers are fairly scary at the moment, giving a fairly low amount of flexibility for both the MoF and the RBI on the interest rate front. So the medium-term worries really haven't gone away as such.

Q: What is your immediate worry for the month of June itself when 9.5% hits? You also have Dr Reddy's statements that came in yesterday that conventional and unconventional methods will be used to fight inflation is perhaps the sixth time he is saying. But there was also added emphasis on liquidity. What have you read from those statements?

A: Clearly inflation prints are going to come out higher. As you mentioned, two weeks down the road we will get probably a 9.5% or so inflation print. That makes real interest rates negative, which really cannot sustain itself.

There is of course the other school of thought that this is a 4-5 month kind of phenomenon, things should settle down after that. There are also bright spots in the market that will tell you that one year down the road thanks to the base effect you will see a fairly low print of inflation if things go the way they are going right now.

But I think the worrisome trend in the medium-term really is on the fiscal side. If instead of the 2.5% print that we have been told to expect, including off balance sheet items, and including the concessions made on the fiscal side to control inflation, if the actual print comes at closer to 6% then we are talking of really a very different scenario. We haven't seen 6% print on fiscal deficit since 2002-2003 on an overall basis. So, that is something that is really worrisome.

The positives though in the medium-term, given that there are so many negatives, one is that over the last week we have seen the Fed talk about commodity prices and the linkage to the strength and weakness of dollar against commodity prices. If they take that seriously, then hopefully we can cap the dollar weakness and consequently the commodity prices as well.

Over the last few weeks, we have also seen a lot of pass through going into the system of oil prices, not just in India, but also in other countries in Asia and around the globe. That could mean a lower amount of demand in the system and hopefully demand-supply would catch up with each other.

But at the moment, the flexibility available on the fiscal front for the RBI and the MoF is extremely low, which is worrisome, quite unlike for instance, the flexibility that we have as a country on the FX side.

Q: Practically everyone knows that liquidity is, even at this moment, just about enough. Come Monday, we might see call rates go even above 7% because today's auction will take away Rs 10,000 crore and June 15 will take away much more by way of advanced taxes. Everyone knows that the system is getting tighter for the month. Why would you think Dr Reddy would have given that much emphasis on liquidity? Would it mean that he would still fight shy of repo and indulge in that tokenism of a CRR hike or are you reading something else?

A: It is a tough call for both the MoF and the RBI. It is a very unenviable job at the moment. We are fighting with the dreaded 'S' word here; nobody wants to talk about stagflation. But the possibility is looming over the medium-term horizon.

The headline numbers - 9% GDP growth in the last quarter of last fiscal. Credit offtake seems to be picking up again slightly towards the 24% mark. So, there are signs that the RBI can see and try and do a bit of demand management. So, it cannot be ruled out that they will do a repo rate hike. But I guess over the medium-term, we all know that a slowdown could be around the corner.

Q: Are you expecting a CRR or a repo rate hike from Dr Reddy in the next month or so? What will be the impact on the 10-year in either case if there is a CRR and if there is a repo?

A: Both of these instruments I think would be on the radar for the RBI. We saw a very different message coming on the April credit policy. But at this moment, they would clearly be considering that given the new data that has come out.

On the medium-term, the 10-year bond that has already moved up about 50 basis points post the credit policy. The yields could head up further higher as a measure of the real interest rates needing to catch up. Plus the flexibility that the RBI has even with its monetary policies is quite low at the moment. If the fiscal side remains as it is, it doesn't really matter whether the RBI hikes or doesn't hike rates. The supply itself will push rates towards the higher rate side.

Q: In case the RBI indulges in another round of tokenism, and doesn't touch repo and only touches CRR, what do you think will happen? It was a 0.25% CRR last time. Everybody knew it only seemed to be some kind of a gesture. If that happened, this time around, what is the upshot in the bond market?

A: The short run yields would come off. Clearly a lot of people have been staying away from the bond market expecting yields to go off. So, they might be brought into the basket again. But post that, it would depend completely on whether oil prices subside or not. If the tokenism, as you put it, is combined with oil prices coming back to sub-100 then clearly there will be a lot of relief all around and things will settle down. But if it doesn't, then the fiscal side starts to act up again, and this would be a matter of time I guess.