The rupee is likely to remain around the present level, whereas bond yields could inch up to 7 per cent level in the near term on concerns of widening fiscal deficit, according to currency and bond dealers.
Finance Minister Nirmala Sitharaman last week cut corporation taxes, which would result in foregone revenue of about Rs 1.45 trillion. The 10-year bond yields had shot up 15 basis points to close at 6.78 per cent on Friday in response. The yields closed at 6.75 per cent on Monday, as investors bought bonds ahead of the release of a revised liquidity framework report by the Reserve Bank of India (RBI).
The liquidity framework is expected to make rate management conditioned on the prevailing liquidity in the system. For example, if there is a certain extent of surplus liquidity, which drives down the yields, the market can expect rate hikes and vice-versa.
Still, most bond dealers expect the yields to reach at least 7 per cent, and can go beyond that by December, but not by a wide margin.
“The tax cuts will lead to an improved credit demand, increased cash flow to the companies and will ensure better maintained demand for liquidity. This may push up yields in the market,” said Dhananjay Sinha, head of research and chief economist at IDFC Securities Ltd.
But yields would fall back in the medium term, according to Joydeep Sen, consultant with Phillip Capital.
“Rate cuts are still there on the table; real interest rates are positive. Driven by the RBI’s benign outlook and extent of OMOs over the course of the year, yields will trace back in the medium term,” Sen said.
The RBI buys or sells bonds from the secondary market under its open market operations (OMO) programme. The market expects the RBI to purchase bonds to drive down yields, starting October.
But there is no concern as such on rupee. Currency dealers say even as rupee should have appreciated sharply following the equity markets cue, it could not do so as other currencies in the region followed cues from China and remained weak.
A stronger rupee also complicates the dilemma for the policy makers who want India’s exports to boost. So, it is likely that the RBI would intervene actively to let rupee relatively weaker against the dollar.
“Rupee should remain stable. The rupee, in our view is structurally over-valued and ideally it should depreciate, but keep an eye on crude, prices of which shows some hardening tendencies,” said Sinha.
According to Bank of America Merrill Lynch (BofaML), while rupee has strengthened from 72.4 a dollar in September to 70.94 level now, due to a variety of factors, including tax cuts, “improvement in domestic sentiment, especially on the supply side, may not translate into improved demand just yet, meaning that FPI equity inflows may not recover immediately”.
According to Adarsh Sinha and Rohit Garg, currency analysts at the BofaML, negative impact on the fiscals “could potentially overwhelm positive impact on corporates”, even as policymakers wouldn’t want an appreciating
rupee that would offset any easing in financial conditions from recent measures.
Besides, risk from external factors such as Chinese renminbi and crude oil remained significant and investors seemed to be bearish on the rupee.
As such, rupee may not appreciate much, but it should be managed to remain stable at around the present level. “Stable currency will also ensure price stability and stable interest rate over the medium term,” said a currency dealer with a large bank.