RBI may not scale back liquidity measures in Sept: Barclays

Rohit Arora, EM Asia Rates Strategist, Barclays expects the US Federal Reserve to taper by USD 15 billion and cautions that this could cause weakness in emerging market assets. In such a scenario, he also foresees rupee weakening as well and hence does not see the Reserve Bank of India (RBI) scaling back its liquidity tightening measures in the upcoming meeting. He further added that bond yields and overnight index swap curve may move higher.

"If RBI does not scale back their liquidity tightening measures and the MSF rate remains at 10.25 percent, we think there could be somewhat disappointment from the fixed income markets and we could see around 10-15 bps move higher in the bond yields," he told CNBC-TV18 in an interview.

Guidance given by the new RBI governor would hold a lot more importance than any change in existing measures, believes Arora.

Also read: Questions over Fed chief a bigger issue than taper

Below is the verbatim transcript of his interview on CNBC-TV18

Q: What is your own sense of the way the FOMC thing will play out and how will you outguess RBI’s moves on September 20?

A: For FOMC, our broad view is expectations of tapering of around USD 15 billion, which is slightly more aggressive than the market. If we are right then there could be another leg of weakening in emerging market (EM) assets following the FOMC meeting. This in turn could imply that INR, which is one of the vulnerable currencies, could weaken to an extent.

In that scenario, we think Central Bank is unlikely to scale back their liquidity tightening measures at least at the upcoming meeting and that could lead to a move higher in bond yields as well as the overnight index swap curve.

Q: If the RBI does not have the scope to reverse that 10.25 percent marginal standing facility (MSF) rate then what do you see as a reaction on both the bond markets as well as on the currency?

A: On the currency, the drivers will be first of all external events, which is FOMC but over the last few weeks we have seen that positive catalyst have been building up for the currency. For example, we have seen a sharp deterioration in the current account deficit (CAD), their expectations of a pick up in capital account flows coming from one is FCNR deposit scheme, which was launched by the new Central Bank governor on September 4 and second one is there are increasing expectations that there could be a pick up in bond inflows after the regulators have eased the investment norms there. That will definitely help the rupee in the medium-term.

In terms of bond yields, if RBI does not scale back their liquidity tightening measures and the MSF rate remains at 10.25 percent, we think there could be somewhat disappointment from the fixed income markets and we could see around 10-15 bps move higher in the bond yields.

Nonetheless, it will be very much dependent on how the Central Bank guides the investors for their outlook. Especially since this is new RBI governor’s first meeting and investors don’t have a lot of sense on what the bias would be. So the guidance would hold a lot more importance than the change in any existing measures.

Q: If the currency were to hold steady and the tapering is a little lower than what you are saying and the sound is dovish from the Fed, is there a possibility that the RBI doesn’t change the repo rate but probably scales from 10.25 to 10 percent the MSF rate or probably does even more minor tinkering like the 99 percent cash reserve ratio (CRR) on a daily basis is reduced to 90 percent - if some such moves come, do you think that there is a chance that bonds may rally a bit at all?

A: Yes that is a fair point and in fact that is what a lot of investors have been expecting. We think it is going to be a close call, especially if FOMC is slightly on the dovish side and INR rallies towards 60/USD. However, even in that scenario, our base case is that RBI is unlikely to scale back the liquidity tightening measures at this meeting.

Moreover since these measures were introduced in the intra meeting there should not be any hurry to reverse the measures at the policy meeting itself. As and when the flows pick up and INR sees a longer period of stabilization than the Central Bank can definitely scale them back in the next few weeks.