 "Expect efforts from new govt to bring inflation down: Pradeep Madhav")
Pradeep Madhav, managing director, STCI Primary Dealer, spoke to Neelasri Barman about the bond market and what lies ahead for the economy. Edited excerpts:
What are your expectations from the new government which will be formed soon?
We would expect the new government to immediately start addressing the issue of growth and lay emphasis on reviving the investment climate to set the country on a higher growth track than 4.7- 4.9 per cent expected for the last financial year. Improving the quality of fiscal consolidation by demonstrating a willingness to reduce non-essential subsidies instead of capping the planned expenditure is also likely to be a priority. We would also expect the government to step up efforts to bring down inflation in a sustained manner, which would require action in improving the supply side issues and the state of infrastructure, apart from the use of monetary tools.
The country is continuously facing situations like domestic supply bottlenecks, stalled projects and uncertainties in global environment. According to you, what should be the growth drivers?
Indian growth has been derailed primarily by industrial sector that has been a laggard over the last two years. Major factors that have contributed to the industrial slowdown include shortages of core inputs, weak external demand conditions and high inflation affecting the domestic demand. While the government recently took steps to ease supply-side bottlenecks by speeding up project clearances, its impact will be discernible with a lag. Meanwhile, elections have added to the uncertainty. For now, any revival in the industrial sector depends on improvement in investment outlook, which is possible if election outcome results in a stable coalition. Moreover, the Reserve Bank of India (RBI)’s credibility in containing inflation will determine the improvement in consumption demand. Therefore, the pace of improvement in domestic demand, coupled with improved supply side infrastructure, will assume critical importance in determining growth prospects.
Do you expect any change in the government’s borrowing calendar once the new government comes to power?
The interim Budget that laid out the fiscal deficit for financial year 2014-15 at 4.1 per cent of Gross Domestic Product (GDP) is based on optimistic expectations as regards the revenue collection as well as expenditure. Thus, the risk to the fiscal deficit number being higher is very real. Depending on the thrust to growth and the final Budget figures, some change in borrowing calendar can be anticipated.
Do you expect another status quo on key policy rates in RBI's monetary policy next month?
We expect RBI to maintain status quo in the upcoming monetary policy on June 3. While inflation based on the CPI this week could see a marginal uptick, it is expected to begin its downward trajectory thereafter. However, there are various upside risks in the form of inclement weather conditions and volatile global commodity prices owing to Russia-Ukraine strife that warrant continuous watch.
Corporate bonds issuances have dried up from the start of this financial year.
The corporate bond pipeline has dried up since the beginning of the year when provisions of the new Companies Act, 2013 were notified. Under the new regulations, corporate issuers have to create Debenture Redemption Reserve equivalent to at least 50 per cent of proceeds from bond sale, twice of the previous requirement of 25 per cent.
The regulations also restrict the total number of private placements mode of issuance in a year. As an issuer, therefore, timing the market has become more important than ever before. The corporate houses are, therefore, waiting clarification from the front of the Ministry of Corporate Affairs and Sebi before proceeding with their funding requirements. Investment outlook is yet to improve meaningfully, which has impinged domestic Capex cycle. We expect the primary market activity for corporate bonds to pick up following clarification of these issues.
Do you see upside risks to inflation due to Indian Meteorological Department (IMD)’s forecast of below normal monsoon this year?
In its recent estimate, IMD has foretasted southwest monsoon rainfall at 95 per cent of long period average, which is below normal. In addition, there is 60 per cent probability of El Nino during southwest monsoon season. The last time India witnessed drought was in 2009, which adversely impacted both inflation and GDP. Even though there is lot of uncertainty on the occurrence of El Nino, deficient rainfall could aggravate the inflation conditions, which are already worrisome for the policy makers. For RBI, CPI inflation targeting at four per cent with a band of +/- 2 per cent is a little optimistic given the monsoon driven nature of India’s inflation which is beyond control of any authority. In addition, global conditions also exert influence over the domestic inflation conditions. While the monetary side of the economy has tools to battle inflation, it needs to be complemented by fiscal side reforms that are aimed at augmenting supply side as well as curtailing fiscal profligacy.
CPI-linked inflation bonds have failed to lure investors. What, according to you, are the reasons for the same?
The CPI-linked government bonds aim to provide a fixed rate of return or 1.5 per cent to the investors over and above the CPI inflation in order to assure a positive real rate of return. Success of any retail financial product crucially hinges on the product awareness and knowledge which is still lacking. Some modifications in the product design like easing early redemption penalties and improving tax treatment would help to attract a larger demand. On the supply side, banks need to increase the pitch for investment in CPI linked bonds as an available form of investment opportunity along-with their thrust on traditional bank deposits and mutual funds.
When can we expect a new 10-year benchmark bond?
The current benchmark 8.83 per cent, 2023 is liquid, traded actively and has an outstanding of only Rs 48,000 crore. The incremental issuances in securities are held back by RBI when outstanding amounts exceed Rs 85,000-90,000 crore as a prudent debt management measure. It would be reasonable to expect the issuance of a new benchmark 10-year bond in the month of June/July once the new government assumes charge and tables the final budget for this fiscal by which time the outstanding in the current benchmark security will also be nearing the range of outstanding mentioned above.
Why has RBI stopped talking about including Indian bonds in global bond index?
The talk of Indian bonds becoming part of an index was at a high when the country was facing problems of a fast depreciating currency and foreign institutional investors’ (FII) fund flows had slowed down. With the problems on the currency front having eased after the measures taken by both the government and RBI, these reports of inclusion in bond index seem to have receded. However, I am sure that the efforts to attract investment into our markets are very much on.
What are your expectations from the new government which will be formed soon?
We would expect the new government to immediately start addressing the issue of growth and lay emphasis on reviving the investment climate to set the country on a higher growth track than 4.7- 4.9 per cent expected for the last financial year. Improving the quality of fiscal consolidation by demonstrating a willingness to reduce non-essential subsidies instead of capping the planned expenditure is also likely to be a priority. We would also expect the government to step up efforts to bring down inflation in a sustained manner, which would require action in improving the supply side issues and the state of infrastructure, apart from the use of monetary tools.
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Indian growth has been derailed primarily by industrial sector that has been a laggard over the last two years. Major factors that have contributed to the industrial slowdown include shortages of core inputs, weak external demand conditions and high inflation affecting the domestic demand. While the government recently took steps to ease supply-side bottlenecks by speeding up project clearances, its impact will be discernible with a lag. Meanwhile, elections have added to the uncertainty. For now, any revival in the industrial sector depends on improvement in investment outlook, which is possible if election outcome results in a stable coalition. Moreover, the Reserve Bank of India (RBI)’s credibility in containing inflation will determine the improvement in consumption demand. Therefore, the pace of improvement in domestic demand, coupled with improved supply side infrastructure, will assume critical importance in determining growth prospects.
Do you expect any change in the government’s borrowing calendar once the new government comes to power?
The interim Budget that laid out the fiscal deficit for financial year 2014-15 at 4.1 per cent of Gross Domestic Product (GDP) is based on optimistic expectations as regards the revenue collection as well as expenditure. Thus, the risk to the fiscal deficit number being higher is very real. Depending on the thrust to growth and the final Budget figures, some change in borrowing calendar can be anticipated.
Do you expect another status quo on key policy rates in RBI's monetary policy next month?
We expect RBI to maintain status quo in the upcoming monetary policy on June 3. While inflation based on the CPI this week could see a marginal uptick, it is expected to begin its downward trajectory thereafter. However, there are various upside risks in the form of inclement weather conditions and volatile global commodity prices owing to Russia-Ukraine strife that warrant continuous watch.
Corporate bonds issuances have dried up from the start of this financial year.
The corporate bond pipeline has dried up since the beginning of the year when provisions of the new Companies Act, 2013 were notified. Under the new regulations, corporate issuers have to create Debenture Redemption Reserve equivalent to at least 50 per cent of proceeds from bond sale, twice of the previous requirement of 25 per cent.
The regulations also restrict the total number of private placements mode of issuance in a year. As an issuer, therefore, timing the market has become more important than ever before. The corporate houses are, therefore, waiting clarification from the front of the Ministry of Corporate Affairs and Sebi before proceeding with their funding requirements. Investment outlook is yet to improve meaningfully, which has impinged domestic Capex cycle. We expect the primary market activity for corporate bonds to pick up following clarification of these issues.
Do you see upside risks to inflation due to Indian Meteorological Department (IMD)’s forecast of below normal monsoon this year?
In its recent estimate, IMD has foretasted southwest monsoon rainfall at 95 per cent of long period average, which is below normal. In addition, there is 60 per cent probability of El Nino during southwest monsoon season. The last time India witnessed drought was in 2009, which adversely impacted both inflation and GDP. Even though there is lot of uncertainty on the occurrence of El Nino, deficient rainfall could aggravate the inflation conditions, which are already worrisome for the policy makers. For RBI, CPI inflation targeting at four per cent with a band of +/- 2 per cent is a little optimistic given the monsoon driven nature of India’s inflation which is beyond control of any authority. In addition, global conditions also exert influence over the domestic inflation conditions. While the monetary side of the economy has tools to battle inflation, it needs to be complemented by fiscal side reforms that are aimed at augmenting supply side as well as curtailing fiscal profligacy.
CPI-linked inflation bonds have failed to lure investors. What, according to you, are the reasons for the same?
The CPI-linked government bonds aim to provide a fixed rate of return or 1.5 per cent to the investors over and above the CPI inflation in order to assure a positive real rate of return. Success of any retail financial product crucially hinges on the product awareness and knowledge which is still lacking. Some modifications in the product design like easing early redemption penalties and improving tax treatment would help to attract a larger demand. On the supply side, banks need to increase the pitch for investment in CPI linked bonds as an available form of investment opportunity along-with their thrust on traditional bank deposits and mutual funds.
When can we expect a new 10-year benchmark bond?
The current benchmark 8.83 per cent, 2023 is liquid, traded actively and has an outstanding of only Rs 48,000 crore. The incremental issuances in securities are held back by RBI when outstanding amounts exceed Rs 85,000-90,000 crore as a prudent debt management measure. It would be reasonable to expect the issuance of a new benchmark 10-year bond in the month of June/July once the new government assumes charge and tables the final budget for this fiscal by which time the outstanding in the current benchmark security will also be nearing the range of outstanding mentioned above.
Why has RBI stopped talking about including Indian bonds in global bond index?
The talk of Indian bonds becoming part of an index was at a high when the country was facing problems of a fast depreciating currency and foreign institutional investors’ (FII) fund flows had slowed down. With the problems on the currency front having eased after the measures taken by both the government and RBI, these reports of inclusion in bond index seem to have receded. However, I am sure that the efforts to attract investment into our markets are very much on.