See bond yields consolidate between 7.75-8%: Nomura India

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With the expectation of a cut in key policy rates, falling inflation and the chances of open market operations every week, rates strategist at Nomura India, Vivek Rajpal, tells CNBC-TV18 that he expects rates to consolidate around 7.45-8%.

According to him, the government needs more money and so will conduct more OMOs. "Expect another Rs 50,000 crore to be purchased by March," he said. For this, the government will have to conduct OMOs every week of atleast Rs 8000 crore.

Below is an edited transcript of his interview with Latha Venkatesh and Ekta Batra. Also watch the accompanying video.

Q: We did see one 8.06% stick in the bond market on expectations that you will have both CRR and OMO. Now does 8.1% get taken and are we going towards 8?

A: 8% is very likely. Given that RBI is showing it's willingness in bringing back liquidity deficit to 1% in NETL zone which effectively means that there will be a requirement of around 500 billion through OMOs even if we assume a CRR cut on March 15th. This effectively means that we will have OMOs every week and this OMO with monetary policy expectation of rate cuts going ahead, inflation trajectory falling I would assume 8% is very likely within a month or so.

Q: I didn't get the figure in terms of total quantum that you are expecting from the OMO front. Can you highlight that for us in terms of a total quantum and then post that how do you see bond yields to move?

A: At the moment, the Indian banking system has rupee liquidity deficit of around Rs120,000 crore, within next two months. We will also see a currency leakage of around Rs 2 crore so that makes liquidity deficit to Rs 140,000 crore if there is no infusion in the liquidity. If you assume a CRR cut of 50 bps, that's Rs 3.2 crore infusion of liquidity which effectively means that another Rs 5 crore of liquidity infusion is required to bring back liquidity deficit to Rs 6 crore and that somehow matches with a run rate of 8,000 crore or Rs 8000 crore OMOs per week for the next six weeks. So that's the calculation.

Q: So you are expecting another Rs 50,000 crore of bonds to be purchased?

A: Yes.

Q: Would that square with the RBI also wanting to keep inflation on a leash? If the inflation number were to come in unexpectedly bad for January, would RBI's thinking change and will they not want to infuse so much liquidity? Also, this will take the total liquidity to a new high in terms of OMO? Would the RBI be comfortable?

A: It will be, but this is very much required because the liquidity deficit condition in the Indian banking system is way above the comfort zone. The governor is very clear that he wants liquidity deficit within 1% of NETL. As far as it's inflationary impact is concerned, the view is that as far as liquidity is in a deficit mode and infusion is happening gradually, it is not inflationary.

Now why the liquidity deficit is to start with it is at such an uncomfortable zone is because of the FX intervention. So during FX intervention so much liquidity has been taken out of the system that one needs to infuse liquidity through OMOs and CRR cuts.

Q: If there is so much of a guarantee that Rs 50,000 crore will come, then wouldn't bond yields slip below 8?
 
A: Yes, it is likely that bond yields slip below 8%. In fact, RBI hasn't committed itself to OMOs every week. It's just that our calculation suggests that we will see OMOs every week and if we do, it is very likely that bond yields slip below 8%.

Q: So currently at 8.14%, what do you think the yield is factoring in, in terms of OMO and on a longer term view what is the trajectory you expect?

A: I expect that bond yields will consolidate between 7.75 to 8% zone because this will be a cycle of gradual cut. This is not a cycle where we will get a frontload of rate cuts and anyways it's a backend so it's not that as if the direct impact comes on the backend of the yield curve. I was saying that the trajectory should be benign; it should be falling till the middle of the year and then consolidating.

However, one factor that needs to be considered is how the Budget comes; if the government sticks to the fiscal consolidation plan and gives some relief on supply front, then the bond yields will stay low. But if they come up with extra supply and if they don't stick with the fiscal consolidation, then bond yields may snap back post median.

Q: What is the meaning of fiscal consolidation now? Chances are you are going to get 5.6% for FY12. What is the number that will warm the market's hearts or is that number not yet arrived at in the market's collective cycle?

A: There are some noises from the government sources that the supply will not be more than FY12. However I think market is even prepared for around 5% of fiscal deficit number.