Do not see outflows from bonds to last long: Barclays

Although falling rupee and deficit concerns nipped chances of a rate cut, Rohit Arora, head emerging markets research head at Barclays believes that the Reserve Bank of India will cut repo rates by 75 bps in the next six months. He admits that inflation may mount on rupee risks, but assures that cannot be the base case for price rise.

To arrest rupee fall, central bank may continue to opt for open market operations (OMOs), he said. Arora also sees a pick-up in bond inflows after the fall in gold prices. The current outflow, witnessed recently, is unlikely to last, Arora concluded.

Below is the edited transcript of Arora's interview with CNBC-TV18:

Q: Before I ask you about the Reserve Bank of India’s (RBI) move and current trends, let me ask you a slightly medium term question on Inflation. The presumption is that inflation is dead, the battle has been won and therefore there are other considerations like current account deficit (CAD), etc. It is the rupee which will determine the central bank’s action but is there an outside chance in your eyes that in 2014, inflation stages a bit of a come back?

A: Our base case is that inflation continues to remain soft at least for the next six-nine months with a probable bottoming out in September. Going forward, in 2014 as well, we are expecting the inflation into the similar ranges and not moving beyond 6 percent. The risk definitely comes from the weakness in rupee which could translate into commodity prices and could transform into higher inflation but that is not our base case as of now.

Q: What is your base case in terms of what you expect the RBI to do then for the rest of this year, whether they would ease more or just stay on hold given the situation with the currency?

A: If you look at the policy guidance which the central bank came up with this week’s policy meeting, they have definitely eased on the hawkish stance which they took at the previous policy meeting. The tone down, the limited room for easing stance which was taken at the May policy and yes the guidance on rupee is a new addition. So yes, there could be a risk for the July meeting if rupee continues to weaken but over a medium term we think there is definitely a lot of easing required to stabilise growth. We are expecting another 75 basis points of cut in the repo rate in the next six months.

Q: Do you expect them to address the Cash reserve Ratio (CRR) issue as well because a lot of bankers point out that it is not so much a repo rate but it is the CRR that needs to give them some relief in the system. Do you expect them to move on 75 with both because that’s quite aggressive?

A: What we are expecting is cutting repo rate in terms of CRR or said other ways, easing of liquidity which is a much required thing right now because we have to get the translation of the repo rate cuts into the bank lending rate cuts. The central bank has pointed out that their preference right now has been open market operations (OMO). They have cut down in the OMO purchases of bonds in the last one month or so but given that CRR is already close to historical lows, there is very limited room to cut the CRR from here on. We do expect the central bank to infuse liquidity over the course of the fiscal year by doing further OMOs. So far, they have done Rs 200 billion of bond purchases and we think another Rs 1.2-1.4 trillion is still possible for the fiscal year.

Q: What kind of foreign investor activity do you expect to see in the fixed income market? They have pulled out about USD 3-3.5 billion from India bonds in the last one month. Do you see more outflows from Foreign Institutional Investors (FII) from the bond market here?

A: In terms of bond outflows, as I said, it was a slight reversal of what we saw of inflows from April to May. If we take a step back and see, the bond inflows actually has picked up dramatically after the gold prices dropped because that’s a very big positive for current deficit and inflation outlook. What happened after that was there were around USD 4 billion of inflows into the market and that definitely helped the sharp rally in bonds as well.

What has happened after the deterioration in the currency and an uncertainty in outlook for the market assets, we have seen the pick up in outflows. The kind of outflows is still unclear. If they were bills which were bought that matured or it was actual selling. Going forward, the kind of response we are getting from real money investors, official institutional is, yes, there is definitely a lot of demand.

I don’t think it can drop dramatically from here on. Over a medium term, it will only pick up. In fact we did a real money client survey, doing a survey of clients in Europe and US and most of the investors were either already setup to buy bonds or were looking to buy more through the course of the year. So the outlook is definitely positive. Yes, foreign exchange (FX) remains a risk but that can be hedged.