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Last Updated : Jun 20, 2013 02:48 PM IST | Source: CNBC-TV18

Unrealistic to expect sharp RBI rate cuts due to weak rupee

The bonds will shortly find takers in banks and mutual funds, says Ananth Narayan, Co-Head of Wholesale Bank, South Asia, Standard Chartered Bank.

With rupee falling to a record low of 59.90, Indian bonds have lost their charm for foreign investors, who have been stampeding out of the debt market in the past few weeks. However, the bonds will shortly find takers in banks and mutual funds, says Ananth Narayan, Co-Head of Wholesale Bank, South Asia, Standard Chartered Bank. Banks need to buy bonds as an income stream, since credit off take has been low.

As of now, range for 10-year bonds has moved from 7.7.25 to probably closer to 7.30-7.50.

The record low rupee has also reduced expectations of the RBI cutting rates sharply, even as inflation has been easing and growth remains weak. The rupee may remain weak in the medium term, owing to global events and the current account deficit, with shortfall per month at $7-8 billion, which needs to be made up by FII flows or by capital flows, Narayan says. At the moment, structural imbalances, which lead to the current account deficit, have large doses of inelasticity to it, he says. Hence, vulnerability will remain until such time that the market has comfort to bring in flows again.

Narayan expects a tepid response from FIIs for today's debt auction. Over the last month, FIIs have net sold around Rs 27,000 crore of government securities.

Q: Your thoughts on the bond market because there trade was frozen and then it restarted. Are we looking at another exodus of foreign institutional investors’ money from fixed income like we saw the last time this first quantitative easing (QE) withdrawal scare came about a month back?

A: I guess with the events of the past couple of weeks globally we have seen outflows going out from the debt market in the form of FII investments. We are seeing some more interest in exiting the last couple of days as well. With sharp move in the FX particularly for the rupee, 10 percent over the last one month and of course the prospects of what that does to monetary policy going forward i.e. is it really realistic to expect sharp rate cuts going forward. There has been a lack of interest from overseas in buying local bonds and I suspect that will remain for a while.

Also Read: Chart: FIIs sold bonds worth Rs 27000 cr since May 22

Q: This morning there was a large accumulated sale situation that the market went into freeze mode. Is it your sense that we are going to see a lot more in terms of selling pressure from the bond market and in that case what kind of eventual targets or immediate targets are people talking about on the yields now?

A: Three things which led to the bond market rally this calendar year; one was FII buying, second was prospects of sharp monetary policy cuts and third was open market operations (OMOs) from the Reserve Bank of India (RBI) to shore up liquidity. All three have been disappointments in the last month or so.

The FII mood has been shocked a bit with the sharp move in the FX. Those who brought in money for buying in bonds without FX hedge got burnt in the last one month. There is a bit of a question mark on monetary policy going forward.

Nobody doubts that growth and inflation are low enough for rate cuts but we are an emerging market and prospects of rate cuts do come down if the FX is volatile and liquidity has improved over the last few days despite the advance tax outflows so much so that the need for OMOs have come down.

On all three basis there will be a bit queasiness remaining in the bond markets. The support will eventually come from banks which need to buy bonds given the credit offtake is not too great at 14 percent and once the advance tax money comes back into the mutual funds, you will see fixed income funds buying into bonds as well. However, as of now we have moved from a range which is closer to 7.7.25 on the new 10-year to probably closer to 7.30-7.50 on the new ten-year.

Q: What kind of targets are you talking about in the dealing room for the rupee? Looks like 60/USD, your thought?

A: Not too far away so could happen. Today’s move, we opened with a gap so by its own way it could see a bit of filling of the gap. However, in the medium run the rupee remains vulnerable, global events do not help. The fact is it’s been emerging market (EM) events throughout the last one month and we continue to have a current account deficit. We will have USD 7-8 billion of shortfall every month, which needs to be made up by FII flows or by capital flows.

The debt side FII flows will remain queasy for a while. We should see money moving from debt funds into equity funds globally; unfortunately I do not think the local equity market give the confidence to bring in money at the moment and while we do have some anecdotal foreign direct investment (FDI), getting prospects of this ongoing basis is quite difficult.

At the moment the structural imbalances which lead to the current account deficit have large doses of inelasticity to it, they won’t correct overnight. Therefore, we will remains vulnerable until such time that the market has comfort to bring in flows again.

Q: There is a debt auction today for FIIs. How do you think that will go given the curious nature of events? Do you think it’s ill-timed?

A: It is as per the calendar so I guess it will go ahead but even if you do get some bids near zero prices, they might not mean much.

At the moment the market is keeping a low probability for a rate cut even in the July policy. Therefore, at the moment the interest will be low. Having said that at some stage we should see a pullback; the global move also looks little overdone. What Ben Bernanke said yesterday is a good bad news; it does mean that the fundamentals in the US are probably improving and the overall system money has not gone away. It’s not yet happened; it should mean reflowing into other sectors. However, it will take a while for the system to settle down.

Q: Any ramifications for RBI's expectations because after the last policy opinion was still split on the middle on what they may or may not do with the next?

A: If you mean the monetary policy then personally I do not think the chances of immediate rate cuts are too high. So, I wouldn’t put too much of probability on July to policy rate cut. Growth concerns remain and inflation and core inflation has come down at 2.4 percent and it’s manageable. However, it is very difficult to expect rate cuts at a time when FX is as volatile as it is.

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First Published on Jun 20, 2013 02:48 pm
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