StanChart bets on 25 bps rate cut, sees bond yields at 7.8%

Bond yields are likely to nudge down around 7.8 percent in the near term as rate cut hopes get stronger, says Stanchart economist Anant Narayan to CNBC-TV18. He believes the Reserve Bank is likely to cut repo rates by 25 bps in its January 29 policy meet. In case the cut goes as deep as 50 bps, yield will decline to 7.65 percent.

Below is an edited transcript of Anant Narayan's interview on CNBC-TV18 Q: There has been a fairly sharp decline in bond yields. Do you see it sustaining below 8 percent?
A: I think it does. We are looking for the RBI to write some monetary easing through the course of this year, may be as early as January and we expect OMOs (Open Market Operations) to continue and liquidity to be on the radar for RBI as well. So back of all of this, expect bond yields to nudge down towards 7.8 percent mark and we should see a 25 bps rate cut coming as early as January. Q: If I had to pin you down for the year given your assumption of how much repo rates might come off this year, what do you think could be an achievable target on the way down for the benchmark yield for 2013?
A: The assumptions we are making is 100 bps of rate cut through 2013. The target that RBI has for inflation at the end of March, 7.5 percent we’ll probably end up below 7 percent given the robust nature of the rabi crop, given the fact that purchasers pricing power seems to be on the lower side right now. So we should go below 7 percent as of March 2013. That gives room to the RBI to ease both on the liquidity side and on the rate side.

If we get a big bang 50 bps rate cut in January which some players are calling for, you could see 10 year bonds going as low as 7.70 or 7.65 percent. But as a base case we’ll get 25 bps from a cautious RBI as they still wait to see how current account deficit pans out and that along with some OMOs should sustain a rally up to 7.8 percent.

There are risks though as ever. Fact is we don’t know what the inflation numbers will look like and we are hoping that the trajectory remains as it was in the last couple of months. The second thing of course is the big question mark on what the fiscal deficit looks like for this year as well as what the election budget for the next year looks like. At the moment, we expect things to be under control and are hoping that the Finance Minister (FM) can manage the juggling on the fiscal deficit side adequately. We therefore expect 7.80 percent to be a reasonable target.

Q: Will it still make sense for fixed income investors to keep adding duration if they have the entire 2013 in mind?
A: I think it does. There is a lot of external investor interest chasing interest rate differentials. A combination of rate cuts, easy monetary policy and external interest for Indian assets should keep it a reasonable bet. One has to be extremely cautious to see how the domestic factors play out. If we see a slippage on the fiscal front or some bad news coming in the second quarter as we come closer to the elections, one might have to rethink at that point of time. But as of now the base case does seem to support a long duration strategy. Q: Where do you stand on the rupee, the recent current account numbers have led a lot of people and rupee watchers to believe that we are not seeing any major appreciation in the near term? What's the band you see in the currency now?
A: It is a precarious balance. We are seeing some very robust capital inflows on the back of global risk on and a lot of hope on the domestic growth front, which is at the moment balancing equally robust outflows on the trade front and those numbers are pretty worrying and persistent.
As a base case, I continue to remain optimistic. The global risk on has legs to it particularly given the strong breath of data coming out from the US private sector. No matter the fiscal cliff is merely a can that has been kicked on the road. But the US private sector has the fundamentals to grow from here. That should sustain the global risk on, keep the capital inflows coming through and give a fillip to our exports as well.
I am also hopeful on the domestic growth front. I am hoping the momentum on reforms continues particularly translating into infrastructure investments being revived and all of us getting some confidence back in the India growth story. I am hopeful that between actions taken by the ministry and by the RBI we could see that happening over the next few months.
So as a base case that should keep dollar-rupee in the 53-56 range which is lower than where the forwards at the moment predict they could end up. And if the India growth story does revive in a very funny way, it could give all of us investment opportunities domestically, as opposed to putting it into gold and wasting resources of the country.
But one can't deny that the tail risk to this scenario is pretty high particularly on the domestic front.
If reforms falter, risks on the micro economic situation which is pretty grim with the level of stressed assets in the system, if they play out strongly then we have an issue. We could see a ratings issue coming up all over again, there is no way a corporate risk manager can start off by assuming that 57-60 is unthinkable for dollar-rupee in this year. Base case is therefore 53-56, bullish on the rupee but watching out for tail risks and trying to buy insurance wherever possible.