Mkt sentiment far worse than fundamentals currently: HSBC

The Reserve Bank of India (RBI) needs to, as soon as possible, communicate to the market that it won’t tighten liquidity believes Hitendra Dave of HSBC India. Dave’s views come on the back of massive panic seen in the bond market due to a smothering rupee.

"When the rupee weakens by 15-20 paisa, it results in 4-5 bps rise in yields which is a really disproportional move. Therefore, to have the benchmark move up by 60-80 bps, or whatever it has moved up in the last two-three days, is quite bizarre and quite unusual," adds Dave.
In an interview to CNBC-TV18, Dave says that the Indian market sentiment is currently far worse than its fundamentals. He adds that the trade deficit has improved in the past two months, but clearly the market is not reflecting any marginal positivity. Below is the edited transcript of Dave's interview to CNBC-TV18. Q: What is happening in the bond markets really? At 9.4-9.3 percent shouldn’t it be attractive to buyers?
A: At 9 percent, not just me but a lot of other people would have also said it is attractive. The same answer would be possible at 8.75 percent also. But the reality is the measures undertaken by the authorities and almost single minded focus on bringing stability to the exchange rate market has in the process completely destabilized other markets, essentially the fixed income markets.
The bond market is in a mess right now, so I think most people either no longer have the mandate to or the luxury to take a view whether a particular level is attractive or not. At this juncture, I think risk aversion has completely overwhelmed any other part of the buying decision. So, whether it is 9 percent or 9.25 percent or 50-75 bps higher over the next new days or so, I think there will be very few brave souls who will try and sync that these are good levels to start accumulating bonds. Q: What is the option available now even assuming that the policy makers are able to swallow the pride and say that we got it wrong on monetary tightening? If that were to reverse, would not that be severely adverse for the currency markets? As it is, the currencies don't seem to have found a bottom yet but really what is the policy option, can they reverse and look like they have no tools looks so obviously helpless, looks so obviously admitting that the emperor has no clothes then where is the rupee headed, can they really keep quite and allow the rupee to be Re 1 cheaper everyday?
A: It is a bit of a complicated situation and there are no simple answers. Unfortunately,  there are quite a few of us in the market who from day one had been of the view that the challenge that we have on the foreign exchange market has very little to do with domestic liquidity or domestic interest rates because India is not a very large recipient of debt bearing flows from offshore.
This has been proven and even now, reports says that because treasury yields are higher, hence FIIs are selling bonds or whatever. I don't agree with any of that hypothesis. If that case was true then our yields have gone up so much more than treasuries and our short end yields have just completely gone through the roof. We still don't see FIIs buying the debt portfolio of Indian bonds in the given days. So, this measure was always suspected. The subsequent events unfortunately have proved that if at all these measures had any beneficial impact on the rupee, it was really at the margin. But impact on other markets is turning out to be very tangible and visibly very large.
At this juncture, what is spooking the bond market is as much the fall in the rupee ofcourse and the fact that we have on July 15, seen certain measures introduced when they were seen to be not exactly fully effective. Those measures were doubled a week later and they further announced commercial mortgage-backed securities (CMBS) two-three weeks later.
When the rupee weakens by 15-20 paisa, it results in 4-5 bps rise in yields which is a really disproportional move. Therefore, to have the benchmark move up by 60-80 bps whatever it has moved up in the last two-three days, is quite bizarre and quite unusual.
Somehow the authorities like Reserve Bank of India (RBI) need to convey that further monetary tightening is not on the agenda. I know that is a difficult communication to convey but in absence of that, one would really have to think that in any case rupee is weakening atleast the collateral damage starts getting a bit more contained.
This damage is not only in the fixed income portfolios of banks which is widely reported everywhere these days, but it is eventually going to translate into wider issues because it is a matter of time before EMIs and borrowing rates not just for consumer loans and mortgages but even corporate loans go up.
All of us know the state of the economy and at the margin the marginal borrower will tend to slip into the possibly underperforming loan category. Q: If you had to assess on the trajectory of the rupee where do you think it could possibly stabilize because there were economists who had the rupee pegged at 65 by the end of this year but we are already currently sitting at around 64?
A: Given the momentum and what has happened post Friday and yesterday, it is very difficult to call a number because my own sense is that right now the sentiment is far more adverse than underlying fundamentals.
I am quite surprised that a lot of authorities are not trying to focus the attention of the market on to the trade deficit that we have had for June-July that were both at about USD 12 billion. It is a known fact that the net invisibles which are services plus remittances plus returns on outward investment tends to be around USD 8-9 billion on an average every month.
So, the gap is only USD 3-4 billion. That is not really that difficult to fill, one can’t just fill it up by using the trade credits and by the NRE deposits. One doesn’t really have that much dependence on portfolio flows. So fundamentals actually have improved quite a bit in the last two-three months but the sentiment is extremely adverse right now.
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One really has to see how this whole process of tapering pans out, what effect it has, how much of it is priced in, how much of it is not priced in.
With the recent currency management especially in the last two-three days, one gets the sense that there is a slightly more readiness to accept that there is no one fundamental of the rupee which somebody can determine and then push or take any cost whatsoever, inflict whatever damage on any other aspect of our economy to try and drive the currency to that. One will get the sense that there is a realisation that the only thing you can possibly control is pace, but not direction.
However, I would think momentum is difficult to pinpoint as to when it will stop. If one continues to see these trade numbers for another month or two months or so, then the whole financial market will start realizing that the gap is not as large. Currently, the excess of demand of dollars which is really coming from existing investors who are being pressurized into hedging and anyone who wants to sell dollars just getting scooped,  because if one sold on Friday, they would already be out. The fundamentals are in place but the momentum is not and till such time the momentum is there it is very difficult to call a number. Q: You gave that arithmetic of USD 8 billion of invisibles that come in and a USD 12 billion monthly trade deficit. But even 4 billion is hard to find and as well there could be a situation and there is a situation on daily basis though it is only a trickle of money flowing out. So what you have to actually match is perhaps 5 billion or 6 billion and that money is not there. So, therefore what are the options available? Is there something very fundamental that the government has to do in terms of just right pricing diesel, Rs 5 this month and Rs 5 next month or something as seminal as that so that 4 billion gap is wiped out or narrowed considerably? Will that make a difference to both sentiment and fundamentals?
A: Firstly, I do not agree with the hypothesis that anywhere a number between USD 3 to USD 5 billion is difficult to find because there is a steady stream of external commercial borrowings, non resident external (NRE) deposits and most importantly bank credit for trade purposes.
There is an almost permanency to these three elements. So, it is wrong to conclude that even USD 4-5 billion is difficult. Yes, we have had outflows both on the fixed income side and on the equity side but those are very small. Especially the equity outflows have been very small and debt outflows as has been highlighted by many people in the past, never resulted in dollar supply.
Everyone agrees that for far too long the focus has been on financing the current account deficit rather than addressing the current account itself. I think through gold and other measures, they have committed that it will be about USD 70 billion or so. Looking at the numbers that we have seen from June-July, even USD 70 could also turnout to be a slightly lower than that.
All of us in the financial market and in the economic society would by and large agree with the suggestion that one is making that the diesel price hike a one go, thereby give a shock to the system, tell the society that the dollars are scarce and we do not have enough of it and one can no longer subsidise fancy cars been driven on all the major cities of the country but ultimately that is a political decision. From a market perspective, it would be wonderful if they did it. Whether it is palatable given elections round the corner, I do not think anyone in the financial market will dispute it. It is a political decision.

Q: Do you suspect your arithmetic is also something that the market is buying now because we have seen support coming in at 64.1/USD. It is too brave to expect that that will stand but is there a good chance that people are making the calculation that with the rupee at 64/USD imports will have to fall. That connection is very obvious. A depreciated rupee has invariably pulled down imports, they have done it in July and the fall in non-oil, non-gold imports has fallen by USD 5 billion in a month. So, do you think that calculation is already working and the rupee is finding a level?
A: I hope so, because all of us whichever part of the market we are now in, are seeking a bit of stability because it is becoming very difficult to be able to handle this degree of volatility in all of the market whether it is equity, fixed income or the Fx market. However, at this juncture, for the last three-four days, one gets a sense that the extent of heavy-handedness used to drive the currency to a particular level.
That approach has been rolled back and therefore, as that signal is been read by the market. We are seeing a very move not just intraday during our hours but also in the offshore market after we close.
So, one would have to wait for two- four days to see whether by itself the currency gets to a level where even the so-called speculator or the speculative force no longer feels comfortable being long dollars versus the INR.
Now, whether that number is 64.10/USD or 65.10/USD or when the momentum is there it is very difficult to call a number. However, when one looks back in retrospect and thinks that if this was the original approach adopted, that is of not being very clear what the fundamental level of the rupee is, perhaps the collateral damage would have been less and the reserves still would have been very much around. The market too would have also perhaps corrected itself in a lot more smooth and orderly way rather than the ones that we have noticed. On an incremental basis from June 1 onwards, my bias would be to suggest that those very outlandish numbers that we keep reading about or hearing about, do not have any mathematical basis. They could have a basis based on momentum and sentiment, but just a sheer demand-supply equation doesn’t seem to be suggesting that those are sustainable. Q: If you had to see some steps coming in from the RBI or the government on the rupee further than what they have already done, what would you like to see or what would be the most effective because we did have JPMorgan come earlier and talk about some amount of easing of FIIs in the bond market completely and then we have spoken about sovereign bonds, multiple times. Do you think these two are possibly effective methods also for the rupee now?
A: I think sovereign bond in the current environment is a bad idea and I hope and from whatever one has read the public comments, I do not think there is any appetite to explore the idea either in the ministry or in the RBI. This is good because given the state of our economy, one does not want to have too much of debt outstanding where if the overnight rupee moves, Re 1, we can handle it but if bond yields are made to spike by 50-60 bps overnight, then the tail will be wagging the dog.
I think same on the FII debt limit, I think if there is a lesson to be learnt from recent events, it is that the countries where currencies have got into trouble, of course they have current account deficits but they also have large debt offshore, debt ownership. So, I do not think there is any scope whatsoever. Atleast I hope they do not consider further increase in debt limits for FIIs. If at all there is any proposal of that nature, I would think that the newly formed 5 billion category which is for sovereign wealth funds and insurance and wider defined, real money. That is where they may make the increase because this is much more stable. It comes in a trickle, the 5 billion will happen overly over the next 12 months or so, but that is fine. When it comes then it will tend to stay for many months. I would rather that the limit be increased significantly from 5 and the other limits be collapsed to accommodate that increase.
From a rupee perspective, if one wanted to send a fairly strong signal, one needs to show a wall of money to the financial market and that wall of money, one of the options could have been sovereign bond issue which I myself think is a poor idea.
The only other way out is to do a large NRE deposit equivalent of what we used to have earlier, which is the foreign currency non residential, FCNR (A) and that from whatever we understand from our discussions with people offshore and locally can generate the kind of amounts which will address the sentiment or the momentum right now to compliment the improving demand supply balance through trade.