SENSEX NIFTY
Jul 16, 2013, 11.08 AM IST | Source: CNBC-TV18

RBI's rupee protection could impact bond, stock mkt: Udayan

Measures taken by RBI to arrest the fall of rupee could have deep repercussions for the stock and bond market says CNBC-TV18's, managing editor, Udayan Mukherjee.

Measures taken by Reserve Bank of India (RBI) to protect rupee could have deep repercussions for the stock and bond market said CNBC-TV18's, managing editor, Udayan Mukherjee.

Tuesday will be an important day for all markets and all asset classes, and one can forget about their expectations of a rate cut from RBI because it has just sacrificed the interest of the bond and the stock market to protect the rupee market.

Huge tightening in liquidity could see interest rates go up in the system and bond yields head up too, he added.

Also read: RBI opens new attack to clamp rupee free fall

On possibility of a rate hike by RBI in July policy

We have been talking about this possibility for the last couple of weeks. People have been in denial that a rate hike cannot happen right now, but the signs were there. Other peer markets were doing it. Brazil was doing it. Indonesia was doing it and Brazil does not have any better growth prospects than India at this point. So, if they could do it why couldn’t we?

Therefore, today the penny will drop, the denial will be shaken. The Reserve Bank of India (RBI) has used its judgement and sacrifice, as I said the interest of the bond and the equity markets for the currency market. Time will tell, because this move by RBI will be hotly debated. In the least its contentious, some people might think it is a policy mistake as well given the kind of growth dynamics India is dealing with.

The good thing is that the rupee market will be salvaged atleast for the next few days, but at what cost is the big question? You have seen the Index of Industrial Production (IIP) numbers last Friday. We know that we are starring at five percent growth right now. At a time like this to curb liquidity to almost force banks to up rates, for an investment cycle which is completely moribund, for them to deal with the prospect of interest rates going up and what it does to sentiment all around in the system - those are big questions.

Although one can say that the RBI’s priorities are different and that is a different game. But I think it is very stock-negative and fairly bond-negative as we look at some kind of saving face in the rupee.

On foreign institutional investor (FII) flows

That is a million dollar question because there will be some capital losses for FIIs in the bond book right now because bond prices will fall this morning but what all emerging markets (EMs) are trying to do including India now is to make our country bonds more attractive for FIIs in the longer-term, which means we need to see some more FII flows in, for medium-term investors. That is the game clearly in raising interest rates at a time like this.

However, what it does to the perception of a country where growth is crumbling is a difficult call. Also, RBI is keeping an eye on the FII outflow from the bond market and it has been lulled into complacency into believing that there is money, which cannot go out of the equity market. Although the experience of last month says that it is bonds which hurt us more than equity outflows but if people start taking a dim view of India in the light of further tightening of liquidity interest rates and they say India will grow at 4 percent next year, then you could see a big outflow of money from the equity markets. This might more or less or even more than compensate for any inflows which come into the bond market.

So, it is a judgement call but this is a contentious call because you have just taken a decision with an eye on the rearview mirror because equity outflows will not happen in India. However, if suddenly we were to lose USD 10-20 billion of equity outflows, the kind of damage we could do to the system, to the market, to sentiment could be quite scary.

I hope it works out well but there is at least a one-third possibility that this could end up being termed a policy mistake.

On bond, rupee, equity markets

Bond and equity markets go together this morning because bonds yields heading in a direction of 8 percent is something which the market could not have conceived a few weeks back. It was a question of how quickly we go to 7 percent kind of levels. It was not even a debate whether rates will be cut, it is just by how much 50 bps or 100 bps. And now we are talking about hardening of interest rates, we are talking about the yield going to close to 8 percent, which is hugely negative for equities as well.

I fear for equity sentiment right now because growth numbers are still very terrible and this will lead to capital losses. Therefore, next quarter what will banks report because there will be trading losses now on their books. Public sector undertaking (PSU) banks already have got hammered out of shape. So, this is hugely negative Bank Nifty, it is hugely negative Nifty, it is hugely negative bond prices but positive for bond yields.

On the possibility of banks passing through the interest rate hikes

We already know what basic demand for things are in the economy; what the car sales are like, it may hit real estate as well. It is a difficult call this morning. The only silver lining is that the rupee probably hardens to 59-58.50/USD but longer-term the rupee will move with how the deficits are moving and how the funding of the deficit is moving.

So, if over the next few months, you have a situation that a lot of FII money comes into the bond market that may salvage the rupee for some more time in a durable fashion. If in the next few weeks FII outflows start once again because of the India growth scare becoming more paramount, then the rupee will weaken once again despite these moves because funding of the deficit will still remain a big and humongous task to do.

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