Debt segment positive for bonds; challenges remain: Experts

A proposal to create a separate debt segment on the stock exchanges with regards to corporate bonds is being considered for some time. Mohan Shenoi of Kotak Mahindra Bank believes there is a chance of the market taking it up very well.

He explained that in case of government bonds, trading was switched from the over-the-counter (OTC) method to screen based trading and the markets welcomed the move. "Similarly, I think the separate debt segment on the National Stock Exchange (NSE) is a very good idea and the market will definitely take to this quite easily," he explained.
Jayesh Mehta of Bank of America Merrill Lynch also agrees with Shenoi and feels it is going to be a good move. However, unlike government bonds there still remain some challenges in case of corporate bonds and therefore, a lot has to be done on its macro side to bring in large scale participants into the market, he added.
Mehta further said that certain structural issues still persist and though, the separate debt segment will bring an enabling mechanism to get into bond trading, it will still take time to be implemented.
Ahead of the Reserve Bank of India's monetary policy review on January 29, Mehta is of the view that though, there is an expectation of a 25 basis point rate cut, it might not affect ten-year bond yields to a large extent. He thinks yields will remain choppy and there is very little change of it crossing the 8 percent mark. "Even if there is no cut, maybe it might just react to 5 to 10 basis points. I don't think it is crossing 8 percent again very quickly," he explained.
Taking into account the tight liquidity situation at the moment, he believes a cash reserve ratio or CRR cut is absolutely necessary.
Shenoi also echoed Mehta's sentiments and said, "I don't think the cut in rates will be very aggressive. I don't think the Reserve Bank of India (RBI) has necessary room to be aggressive in cutting rates."
Also read: Reforms kick start can lead Re below 53/USD: StanChart  Here is the edited transcript of the interview on CNBC-TV18. Q: What is your view with regards to the proposal to create a separate debt segment on the stock exchanges with regards to corporate bonds? What do you think is going to change in the landscape of trading on that front? Shenoi: As far as the market is concerned, it takes bond trading in the screen-based method as against the over-the-counter (OTC) system very well. That has been very amply demonstrated in the case of government bonds where we switched the trading over to screen-based from OTC and the market has taken that very well.
A large amount of transaction today happens directly on the screen-based trading method. Similarly, I think the separate debt segment on the National Stock Exchange (NSE) is a very good idea and the market will definitely take to this quite easily.
Having said that, there are certain prerequisites if this has to succeed. First is the market conventions. They have to be standardised. In case of government securities that problem does not exist because the market conventions are standardised. You have 30x360 semi-annual coupon. So more or less, all issuances are standardised. But, in case of corporate bonds, the issuances are not standardised and that possess is a bit of a problem.
The other problem really is consolidation of bond issuances. The Government of India for example consolidates all its issuances to about Rs 60,000 to Rs 70,000 crore. It therefore, minimises the number of different issuances with different coupons and different maturities. That makes it easy to trade in the market, as against that in the corporate bond market where there are multiple issuances with various coupons and various coupon frequencies.
That creates a problem in the sense that there will be multiple levels of securities and it will be very difficult for the market to keep all those securities on the run and most of them then will become illiquid. So that is the other issue.
But from the issuer's perspective, to consolidate issuances it can create ail and problems to them if they make the maturities same for a large number of issuances. Then on a single day the bond will mature and a large amount will mature. That could create an asset liability problem to the issuer.
We have to see how the NSE debt segment is going to handle these issues. If these are handled, I think the market has a requisite mindset to switch over to screen-based trading. Q: You very comprehensively outlined why the bond market is not taking off when we met a month ago. Tell me, because of one more segment being available are we really going to see trades in the bond market? By when do you think we will really see any active trading at all in the corporate bond market, considering the comprehensive set of problems, practically no liquidity and there is hardly any retail appetite of the kind that you see in the equity markets? Mehta: Mohan outlined it very well. The exchange is still an enabler and it is a good move. But, there are also lots of challenges unlike government bonds where you will have multiple security and all that. But, these are all enablers. We still require something to be done on the macro side to get large scale participants into the market and that is still missing. A structural issue still remains. This will bring some sort of enabling mechanism to get into bond trading activity but it is still not going to get things done as quickly as people are thinking. Q: We have seen after the RBI governor’s statement that he is still dissatisfied with the level of inflation and the bunch of announcements coming from the government on controlling fiscal deficit. What are you going with in terms of expectation on January 29 and for at least the first half of the year, what are you expecting from the RBI? Mehta: At least till the Budget, the momentum is going to continue. Even till March, more than policy now it is up to the run up to the Budget and if the expectation is that the fiscal will be curtailed, then we are looking at a softer rate scenario whether we get big cuts or not. But, we are still looking at a softer rate scenario.
_PAGEBREAK_ Q: What exactly have you made in terms of what the 10 year is factoring in at this point in time, it is currently at around 7.85 percent? And the reason I ask is that we have seen a lot of volatility in terms of movement for the 10 year in the previous week itself? Mehta: Yes, I think in between the markets have started factoring in a 50 basis point (bps) cut and after the governor's statement last week, particularly on inflation, I think market has kind of tinkered that expectation to 25 bps. The current things is of course a 25 bps is more than a rate cut and that's completely priced in.
But, more than rate cuts, there is no supply and fiscal being achieved. Around 5.3 percent is being achieved and there is also no credit pick up. So, I think that's really driving the bond market and therefore, we expect the yields to remain choppy irrespective of cuts or no cuts. Even if there is no cut, maybe it might just react to 5 to 10 basis points. I don't think it is crossing 8 percent again very quickly. Q: What is the requirement of a cash reserve ratio (CRR) cut at this point in time because we spoke to HDFC Bank earlier and they said that despite a repo the need of the hour is a CRR cut because of the liquidity deficit which might actually get tighter going forward in February? What is the likelihood of something with regards to a CRR coming through? Mehta: That is what is surprising because this time around the liquidity is actually very tight and a CRR cut looks much more necessary. But, everyone is right now completely talking about a repo rate cut may be because of the last to last policy where they said they will do something in 2013. That is why the whole market is focused on a rate cut and very few people are talking about a CRR cut. But, that is very much required right now. Q: What are you expecting on January 29 in terms of repo and CRR? How many rate cuts will you pencil in and the band that the 10 year might move in? Shenoi: I don't think the cut in rates will be very aggressive. Let us be clear on that. I don't think the Reserve Bank of India (RBI) has necessary room to be aggressive in cutting rates. So, they will be much slower than what the market is currently expecting and I have four or five reasons why it is so.
One is obvious, the consumer price index (CPI) has been recorded in double digits again and it is a cause for worry.
Second is that I would tend to think that the RBI will wait for the budget to be over to take any aggressive step on the monetary side. They would wait for the budget to get over and see what is there in the budget before they take any decision.
The third point is crude oil prices are just not coming down. They are hovering around USD 110 per barrel mark and they have been stuck there for quite some time now. It definitely has its implications on us.
And the fourth point would be the issue of current account deficit (CAD). It is giving absolutely no room for any aggressive cuts in the upcoming monetary policy review. There could be some cuts because the growth issue has emerged, but to aggressively cut the CAD is just not giving any room to the Reserve Bank of India.
Lastly, I think if there is an aggressive cut, the banks will find it difficult to mobilise deposits from household savings and household savings could perhaps move from financial savings to physical savings. Already, it is happening and there is a lot of movement to real estate and gold.
In case of gold, particularly in the last two weeks, an anticipation of a hike in customs duty has significantly increased buying and that in a way puts pressure on the currency. Therefore, my belief is that an aggressive cut on policy rates is not possible. The RBI just doesn't have room for such cuts.
Having said that, there is another technical reason why ten-year yields in particular cannot go down significantly from current levels. As interest rate cut happens, the yield curve has to regain its steepness. So what happens is, if there are successive rate cuts of 25 basis points, the fall in 10 year will be much lesser than 25 basis points and as this goes on happening, you will find that 10 year at some stage will not move for incremental cuts in policy rates.
So my own guess is currently, 7.85 to 7.90 percent is the right range for the 10 year given a 25 bps cut in the ensuing policy. If there is a disappointment, 10 year could go back to 8 percent. However, if the policy rates are cut on a gradual basis, the lowest I see is around 7.5 percent and I don't see it below that. Q: How much of a disappointment or a damp squib will that be, will it be as bad as the repo in corporate bond markets? Will some deals be done at all? Mehta: There is a very active broker market right now on the bond side and a lot of that would actually shift to the corporate bond on the exchanges. So to that extent it won't be a damp squib.