Yields could slip below 8% if OMOs continue: HSBC

Excerpts from Markets Midday on CNBC-TV18 Watch the full show » ALSO READ See what other experts are saying about markets See what FIIs are saying about the markets See what Udayan Mukherjee is saying about the markets

Hitendra Dave, managing director and head of global markets at HSBC India tells CNBC-TV18 that bond yields could slip lower than 8% if the government's open market operations continue. "But if liquidity drifts below Rs 85,000-90,000 crore, then they will not need to continue," he added.

Below is an edited transcript of his interview. Also watch the accompanying videos.

Q: Rupee saw 48.99 per dollar today. Where does it go from here?

A: I think one gets the sense that all the measures undertaken by the Reserve Bank of India in the month of November and December have cumulatively addressed some of the excesses that we saw towards the last quarter of last year. It also seems to suggest that the grip that the authorities have on the currency market is much stronger now. To an extent one would say that the RBI should be by and large satisfied with what level the rupee is. I think a certain degree of depreciation in any case was warranted given the deficit numbers on both trade and current account and the lack of capital flows to compensate for those.

My sense is now, close to 50 levels, the rupee for most part will track what is happening to the emerging market currency basket, news out of Europe and also how the equities are performing. Since the start of the year, clearly this has been a much more happier new year than 2011, so I think the currency is reflecting that all round. I think clearly rupee has outperformed in the first 4.5-5 weeks of this year as it was underperforming in the last 12 weeks of the 2011. So now rupee by and large will react to news flow from abroad but otherwise no significant shift is what we expect right now.

Q: What we thought was a liquidity driven rally, which perhaps still is because of the ECB opening its purse in a significant manner, has now turned out to be supported by some kind of fundamentals. After all the PMI numbers we have got all-round turned out to be good. Do you think there is more leeway therefore more breadth for this rally? Are you going to see it extend?

A: I think the main trigger was that at the end of last year everybody had become extremely pessimistic; as the new year approached everybody was positioned for negative news out of Europe, negative news out of Greece and even the US data had begun to falter. The big game changer was the three year LTRO done on December 22; I think everyone was taken aback by the size of that.

The European interbank liquidity problems and news out of the EU meeting, whether it is on the fiscal side or on the Greece PSI side, appear to be incrementally progressing positively rather than deteriorating negatively. Coupled with data like PMI locally, ISM in US etc, I think one would think that combination of positioning and liquidity is aiding what we have seen in the last five-six weeks.

Q: Of the investors that you are speaking to at the conference, what's the sense that people have about the Indian equity markets and where it might head in this year?

A: Clearly you still sense caution. What has happened to India last year, especially if you are a foreign investor, it's not so easy to overcome that or ignore so quickly. There was double whammy of stock market fall as also the currency. Clearly people are bit more cautious on India than what they might have been expected in the midst of such a strong rally.

People are waiting for the Budget because the monetary policy appears to be incrementally becoming clearer as to which way directionally we are headed if not timing wise. If the Budget shows some strong measures on the fiscal correction side, at least some of the big macro headwinds that the country has faced will get addressed.

The appreciation of the currency clearly helps people because the sharp depreciation of 15-17% took people aback. The currency appreciation and RBI stance change everything is helping a little bit. Data like this PMI helps us watch concerns that the economy is really grinding to a halt. Anecdotal data seem to suggest that there are sectors where there is a specific problem but otherwise the economy is still ticking along reasonably well.

Q: What does your audience appear bullish on and how is it reflected in terms of sectoral preferences?

A: I think people have taken into account sectors which either benefit from the currency stability or the currency depreciation plus stability. So I think in the export side, on the consumer side there is never been that much concern per se. Clearly on the banking side people need greater clarity; we had an excellent panel discussion in the morning here where the panelists pointed out that restructuring is merited. Restructuring does not mean we are hiding losses, we will take the pain in the short term but the underlying projects will deliver cash flow subsequently.

So one gets the sense that apart from sectors which are very much in the policy domain space where there are land acquisition issues, fuel supply issue, etc those set aside. By and large on the consumer and interest rate sensitive, there is a sense that perhaps the worst is around behind us.

Q: What do you expect personally on the bond market? Are you factoring in another CRR cut, one OMO has been announced will they make a habit of it? Will six of them come in the next six weeks? Where do you see the trajectory for bonds?

A: As far as bonds are concerned very clearly, the issue really is of demand and supply. Supply numbers by and large are known and from all accounts I don't think there is any intent to exceed the already very high borrowing number. I hope that's true and that actually happens that the revenue numbers and the expenditure numbers support that.

So clearly what has happened is from November onwards there has been effectively net nil supply into the system because you have Rs 72,000 crores of buying by the Reserve Bank, some Rs 20,000 crores by FII and which is exactly equal to the almost the size of the supply. So given the fact that banks have a naturally expanding balance sheet, you would think bonds in the absence of any additional supply shocks will by and large be supported. OMO's clearly are helping, we have seen over the last two days what's happened after a impression which was gained that CRR is a substitute for OMO, we have seen that the yields which sort of spiked on the policy they have rallied yesterday and today.

With OMOs continuing, most people will talk about yields slipping below 8%. Whether RBI continues OMOs or not is really, it's a speculative question. I guess if liquidity does deficit, does drift below whatever Rs 85,000-90,000 crores then they will find difficult to justify so and they won't need to do so also. But if they do continue and especially in the choice of security they announce buying of bonds which are what we call on the run we can have overshooting of yields beyond what potentially could be justified.