Stay out of G-Secs ahead of RBI policy: Mohan Shenoi

It would be preferable to stay out of the G-Sec market until the RBI policy is announced, says Mohan Shenoi of Kotak Mahindra Bank. He is not sure whether the tight monetary conditions that were implemented on July 15 will be reversed today or not.

He expects the rupee to trade in the 61.50-63/ USD range. According to him, rupee should not be allowed to appreciate below 61.50/ USD. "RBI depleted its reserves during the difficult time in the last two months, so this is the time for the central bank to replenish its reserves. He expects RBI to buy dollars to replenish its reserves," he told CNBC-TV18 in an interview. If RBI cuts rates today, then the 10-year rate will go down, but it won't go below 7.90 percent in the lower end. Also Read: Rally in CAD- challenged India to be short-lived: Nomura Below is the verbatim transcript of Mohan Shenoi's interview on CNBC-TV18 Q: How would you trade the G-Secs before the policy? A: I would actually stay out of the G-Sec market until the Reserve Bank of India (RBI) policy is announced. The reason is that I am not very sure whether the tight monetary conditions that were implemented on July 15 will be reversed today or not. I will tell you why this confusion is there in my mind. The reason is that the RBI has opened the swap window wherein the Foreign Currency Non-Resident (Banks) - FCNR(B) deposits can be swapped by banks at 3.5 percent semi annual interest rates with RBI. Now the effective cost of those deposits that is the landed rupee cost is around close to 10 percent and most of these deposits are coming in the five year tenure not even three year tenure. So banks will be very hesitant to lock into five year FCNR deposit at effective cost of 10 percent plus. Q: This is 10 percent despite a cheaper swap of 3.5? A: Yes, the reason is no cover is given by RBI on interest on those FCNR deposits, which has to be covered in the market. Secondly, most of these FCNR deposits are coming in yen so the cost of swapping from yen to dollar is a separate cost which the banks have to bear. So if you add these two the cost at least yesterday was coming somewhere close to 10 percent. Now if the RBI reduces interest rates today, the problem is that banks will find it difficult to lock in for five years at such high cost into these FCNR deposits. And therefore we may not get the expected inflow of USD 10-12 billion from this source if we reduce the interest rates. So the RBI has two options, if the rates are brought down then the swap rate which is at 3.5 percent also has to be brought down to make it attractive for banks to lock into this rate. Else the rates have to be kept high at the current levels at least until the swap window is closed. Q: So if the short-term rates, the marginal standing facility (MSF) rates are not lowered today as against expectations, then how do you see the rupee move, what could be the kneejerk reaction? A: Rupee at best can go down to 61/USD, not below that and at the upper end it could be 62.50-63/USD that could be the broad range. In my view the rupee should not be allowed to appreciate below 61.50/USD. The reason is as per the six-country Real Effective Exchange Rate – REER, the fair value of rupee is somewhere around 60-61/USD. So we are very close to the fair value of rupee. RBI has depleted its reserves during the difficult time that we had in the last two months. So this is the time to replenish that reserve and therefore I am expecting rupee not to appreciate beyond 61.50/USD simply because I expect RBI to buy dollars in order to replenish their reserves and that is the reason it should broadly trade between 61.50/USD and 63/USD.