Madan Sabnavis
That yields in the government security market would decline so much was not quite expected after the last credit policy. The consensus target for the 10-year government security was placed in the region of 6.75 percent. However, the continuous decline to the range of 6.30-6.40 percent is indicative of how investors feels about the overall state of the market and the future direction of interest rates.
Let us look at what is making the yields go down at a time when the government has still a gross borrowing programme of Rs 7.1 lakh crore which is unchanged from the amount announced in the Interim Budget.
First, liquidity is easy. Incremental credit over March has declined by Rs 1.23 lakh crore compared with the Rs 83,200-crore fall in deposits. This is manifested by banks suddenly changing over to the reverse repo window (for parking excess liquidity) compared to using the repo/term repo window (to borrow money) earlier. There is clearly a higher quantum of liquidity with banks. This has enabled a larger quantum of borrowings in the period so far relative to last year. Support also came in through the central bank’s open market purchase of bonds in May and June.
Second, the budget made the novel announcement of borrowing from the global market and subsequently officials from the finance ministry indicated that there could be a target of $10 billion of sovereign bonds to be raised in the international market which is approximately 10 percent of the overall programme. This means less pressure on liquidity as well as a lower supply of domestic bonds which pushes up their prices and drives down the yields. This is exactly what has happened.
Third, the icing has been provided by the latest economic data release, which should have normally been a non-event as IIP has always been stagnant and CPI inflation has been low. But if this is combined and woven into market sentiment, the result is that it is assumed that the monetary policy committee will lower rates in the next policy meeting by at least 25 bps. The market is not really wrong because the RBI has been lowering rates continuously by 25 bps each time the background has this twin image. The g-sec yields are just reflecting this sentiment.
The overall mood is also supported by the Fed talking of lowering rates, ECB indicating more easing, the rupee becoming stronger and FPIs continuing to be gung-ho about Indian markets. These are the ideal support ingredients for the final dish which is being served in the market.
While all this makes sense, the question is whether another rate cut will help? The RBI has already lowered the repo rate by 75 bps and while it is debatable whether or not the transmission has taken place, industry is not investing more at a discernible pace. The MCLR and base rates changes do not indicate strong transmission while the Weighted Average Lending Rates (WALR) on new borrowings indicates that there is a link albeit after a lag of 3-6 months. However, the willingness to lend and the purpose to borrow are important for the dots to be joined.
Banks definitely are in a better position than they were two years back when the AQR process began. Public sector banks (PSBs) have been capitalized and more will be on the way as per the Budget. Also, more among them will be out of the PCA (prompt and corrective action) framework which will be good for the system. But do they have the risk appetite? Will they be willing to lend to infra?
Probably not yet, as the latest RBI regulation on large exposures penalizes banks if they lend to companies which have over Rs 10,000 crore of debt that is not accompanied by bond market borrowing. Besides, lending to retail has been the path chosen by most PSBs where the probability of delinquency is lower. Also the NPA ratio for the PSBs is still high at around 10 percent which is still worrisome even though the incremental build up is under control.
Now let us look at the borrower’s side of the story. There is still surplus capacity with industry and even though RBI data shows that capacity utilization improved last year, the buildup of inventory in the auto and consumer durable segments means that all is not well and that investment will not flow any time soon. Sectors such as steel and power also have cases pending resolution under the insolvency process which makes fresh investment less attractive. This is one of the reasons as to why the constant reduction in interest rates has not been associated with higher capital formation. In March 2014, the repo rate was 8 percent. In July 2019 it is 5.75 percent - a decline by 225 bps. The WALR on new loans has come down from 11.52 percent in September 2014 (this is when the RBI began presenting the data) to 9.76 percent in May 2019, down by 176 bps. Yet capital formation has come down from 31.3 percent of GDP to 29.3 percent between FY14 and FY19. (It was 34.3 percent in FY12).
In conclusion, the fall in g-sec yields is understandable because investors are assuming further rate cuts. However, one can still not be sure if these cuts will deliver higher investment when the broader economic environment is not yet conducive. The broader question is how much longer will this rate cut saga carry on?
The writer is Chief Economist at CARE Ratings. Views are personal.
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