Interest rates in India to follow global cues, dip lower: LGM

India may not have to worry about high inflation, says Jeff Chowdhry of LGM Investments. Rather the country is going to witness inflation declining. So, interest rates in India will from here on follow the global trend and move lower, he says.Bond yield will also move lower in the coming years, he says. Neeraj Gambhir of Nomura India says the 2026 bond yield may slip to 6.75 percent in the near-term.Sajjid Chinoy of JP Morgan says he expects another rate cut in the December Policy. He is not surpised by today's decision to cut rates by 25 basis points. But he says a higher GST rate may constrain the RBI from any further rate cuts in 2017. Chinoy expects to see inflation moderate towards 4 percent. Below is the verbatim transcript of B Sriram, Jeff Chowdhry, Sajjid Chinoy, Neeraj Gambhir interview to Latha Venkatesh on CNBC-TV18. Q: How did you read this tweak to the framework, yet this upward bias, does this leave space for a cut, a series of cuts? Chinoy: I am not sure the framework was necessarily tweaked, so to start with I am not surprised by today’s action we thought it was a very close call, there was a chance of a cut today versus December. Remember, the Reserve Bank of India (RBI) is basically operating under the legal change to the RBI Act, which says that they have to get to 4 percent inflation over the course of the next 5 years, that does not specify any particular timeline and as the Governor said the previous timeline was self imposed by the RBI, which is now superseded. As regards the real rate, we made the point very much in the past that there cannot be a static line in the sand, the real rates are very dynamic concept. It is a bit like potential growth invisible, its unabsorbable you have to touch it and feel it and exactly like Dr Patra said, when global conditions change, when India’s potential growth rate changes that changes the neutral real rate as well, so I did not perceive today to be a change in framework, the RBI is interpreting as they should. I do think however that given where food inflation dynamics are, the space for another cut in December likely opens up, we would pencil another cut in December and secondly that there is also the possibility of some additional easing in 2017, because if you look at the RBI baseline forecast, notwithstanding the HRA increase in the GST, they are looking to see inflation moderate towards 4.5 percent. Now they have this band of 4-6 percent so if growth remains anaemic next year and inflation is moderating to 4.5 percent, I won’t rule out more easing next year barring these two big uncertainties, if there is a big increase in the HRA and second round effects or the GST rate is much higher that will constraint the RBI’s case. Q: Are you getting a sense and that’s comment that came from some observers that the Reserve Bank has shifted just that bit from an inflation fighting machine to a pro-growth machine? Chinoy: I don’t get that sense. I think over the last year you have seen that every time inflation has moderated and the RBI has more conviction that they are going to meet their intermediate targets, they have been able to cut rates, that’s being the mechanism over the last 15-16 months. I think the difference you asked what changed between today and August, I think two things changed one is fundamentals on the ground there is more conviction all of us now that food prices will decline more sustainably. You had a normal monsoon, sowing has been strong, there is more conviction that the 5 percent will be met or perhaps undershot, which is what none of us had back in August. The second is of course we now have a MPC, so we now have collective wisdom of 6 people and that is going to have some impact on their policy preferences and their policy choices, but I would not from today’s policy takeaway the fact that the inflation fighting credentials of the RBI are in anyway diluted. I think they made a lot of emphasis on the point that they want to hit 5 percent and that they see inflation going down to 4.5 percent a year from now. I will just make one quick point there is a cost to high inflation, but there is also a cost to disinflating too quickly what economist called the sacrifice ratio, so yes we do need to get to 4 percent and it is important that the government and the RBI ensure that in the not too distant future, we get to 4 percent but inflation this year ends at 5 percent and next year ends at 4.5 percent and we see inflation moderating further, that’s a perfectly acceptable trajectory to markets and investors alike. Q: It looks like further cuts will come, should we expect that bank lending rates are going to fall? By December how much do you expect, by March how much do you expect? Sriram: Since April 1, we have moved over to the marginal cost of lending rate (MCLR) and that gives us the flexibility of taking down or calculating the MCLR on a monthly basis. The data points are very clear in the sense that 7 days prior to the fixation of date which can be fixed by the board, the outstanding balances of deposits and borrowings are taken and what is the marginal cost of funds is arrived at. Based on that the MCLR fixes automatically. So, the issue is that as we have seen from April 1 2016, every month we publish the MCLR. That over a period of time now for the last 6 months has come down by about 25 basis points. So, the trend is there, I think the issue is that we need to go forward in terms of trying to bring down the liability rates, the deposit rates and of course the cost of borrowings will go down as the repo rates go down. So, automatically as data points are put in and the calculation is made there is a scope for decrease in rates. Q: You have the economists saying that he is expecting another cut and probably some cuts in calendar 2017 as well. The bond expert is telling us that another 15-20 basis points in the 10 year yield also is very much on the cards. Given that and the RBI is telling you that they are looking at actually a 4.5 percent inflation in 2018 though that has got a lot of caveats, given all this won't your liabilities fall? Can liabilities price fall by 25 basis by December? Can it fall even more by March? Sriram: It won't fall proportionately. The way the liabilities are structured 40-43 percent of the deposits are CASA deposits which are rate agnostic and it is the other ones that will bring down the cost of funds in some way - the remaining 60 percent. On that 60 percent there is hardly about 5 percent which is dependent on direct market borrowings. So, the combination of all this is directly factored into the calculation of the marginal cost of funds which immediately implies that the MCLR impact will be there but how soon, obviously it will be once a month in terms of fixation of the MCLR and the data points that are there. However how much every month is something that we need to wait and watch, how fast the deposit rates start to reprice and the marginal cost starts to impact. Q: Does life become easier for a banker and a borrower if the cost of money is going to fall in the next 6 months by 25 or 50 basis points, do you think you get market to market gains and you also probably are able to save some borrowers from going under? How does life change as a banker? Sriram: It does profit both ways in the sense that both for the borrower of course the cost of funding is a very important piece of their costs and as we try and reprice our loan book, while there will be a sort of a slight pressure on the margins till the liabilities start to also come down in terms of pricing. However overall I think the profits that you will make out of treasury is probably more than compensated for the loss in whatever little margins that are there. So, in that sense I guess it is a win-win for both the borrower and the banker. Again as I said most of the liability book of the banker is in fixed rates and to that extent once the MCLR starts to kick in for the full year then you will know that the reset of these MCLR rates happens once a year depending on the rates that has been offered to the borrower. Generally it is a one year MCLR that is done and to that extent I think the transmission of rates across the system would be much more faster. That would mean in another six months more till the whole system adjusts to the MCLR regime. Q: What’s your take on this entire thing from an equity investor point of view, does it look like overall the cost of money is going down or is it not going down as fast as you thought. Your key takeaway as an investor? Chowdhry: Let me just start off by saying the thing which has happened on the global scene in the last couple of year, which has taken everybody by surprised is how quickly interest rates have come down and how far yields have come down. No banker, no economist, no strategist in the world predicted two years ago that we have negative interest rates in many of our markets and the problem is not one of inflation, it is one of deflation. India is now starting to go down that trend now, where effectively the story is not going to be about inflation in next 3-4 years, is actually how far inflation can fall so in that environment my prediction is, is that interest rates in India will follow a global trend of being much lower in the next 2-3 years, yields will be much lower in the next 2-3 years and it will not be surprising if in 2-3 years time we are talking about inflation of 2-3 percent rather than 4-5 percent. Q: As an investor therefore what would you pick in India, would you pick India itself and within India what? Chowdhry: We continue to like India very much, our global emerging market funds continues to have India at it number 1 position. We like India for a number of reasons not least of which is a consumer and also financial stocks. We think the environment that we have at this moment in time with good growth and interest rate coming down is a very good one and so companies in the consumer sector like ITC, Nestle, Emami these type of companies we think will do very well going forward. Q: After listening to the governor and the statements there from what is your sense of where the 10 year bond will be on December 31, where might it be on March 31? Gambhir: Like you said there is now a new framework that the market has to contend with and what that framework entails both in terms of monetary policy communication as well as the style of decision making there is a possibility that you have further rate cuts down the line. We have already seen 10 year bond yields rally by 10 bps. It could kind of swing down to 6.75 or thereabouts anticipating maybe one more 25 bps rate cut but thereafter we will have to see what the evolving data is. Lot more uncertainties in the market we will have to contend with. So, I can't see a very sharp decline at this point in time but maybe going down to 6.75. Q: That is the old 10 year. The new 10 year is already at 6.76 or thereabouts. You expect therefore a commensurate fall maybe 6.60. At the moment actually it is at 6.72 the new 10 year. Could that go another 15-20 bps lower, Rae we looking at 6.6-6.5? Gambhir: So the spread between the old 10 year and the new 10 year could narrow because you will have new 10 year supply coming in. Yes, certainly the new 10 year benchmark could do maybe 15 bps or so. Q: Would you say that there is enough falling of cost of money in the bond markets and in the banking system to ensure that growth just picks up that much more? Gambhir: Yes, growth is dependent upon multiple factors but to the extent you need lower interest rates to stimulate the economy. We have seen quite a bit. We have seen RBI cutting rates by 175 bps and certainly we have seen the impact of this show up in the short term money market rates. The governor also referred to the fact that a lot of corporates are actually now borrowing from the money market and the bond markets and there the cost of funding for the these corporates has come down. So, to that extent we have seen a reasonably good transmission happen in the bond markets. The issue has always been that how the transmission can be effected and the banking system rather than the bond markets. Also we have seen some shift between the bank versus the bond market continuing. More and more corporates are looking at bond market as source of financing. So, to that extent the transmission of the rates in the system is progressing. To what extent does it help in terms of growth is an open question. There is not one to one correlation. Many of the things need to fall in place. But from a monetary policy standpoint the task is getting done.