 "B Prasanna")
In an interview to Neelasri Barman he also says the central bank is building up reserves in an liquidity neutral way which is also checking the rupee strengthening above 58 a dollar. Excerpts:
Inflation continues to be sticky. Do you think one more rate hike is in store in FY15?
Headline inflation has been sticky in recent months but has still trended down over the last couple of years. This is mainly driven by food inflation that averaged 11.1% in FY14 and 11.8% in FY13. It is still elevated, but at a much lower 9% levels. Core inflation has been more sticky, currently at 8%, which is close to average of last year and 8.8% average of FY13.
That said, it is also at the lower end of its trading ranges. El Nino is a necessary although not a sufficient condition for sub-par agriculture sector growth. Also, food inflation has not been necessarily high in bad monsoon years, such as in 2002. Efficient food stock management and implementation of strategic steps as delineated in the Bharatiya Janata Party manifesto is critical, although may have an impact from a more medium term perspective.
It is important that Minimum Support Price (MSP) increases are kept in check in the current fiscal, and are in line with the Commission for Agricultural Costs & Prices (CACP) recommendations. Core inflation should decelerate some more, but not significantly so given the expected growth pick-up. It is important that output gap does not narrow even as growth picks up, that is the growth should be Investment led.
That said, in an emerging market economy, Investment growth is typically followed by Consumption growth as well, and therefore there risks to the expectation of a modest decline is tilted on the other side. Thus, in the base case both core and food inflation should edge lower. RBI is likely to give the present government a longer rope if they do the correct things, even if these take more time to impact inflation.
Thus, in all, RBI is unlikely to hike repo rate in the current fiscal. The hurdle for a rate cut is also high. The drivers highlighted above suggest that even if inflation decelerates, the momentum is unlikely to decline so significantly so as to suggest 6% final inflation target can be credibly achieved. Thus, RBI is likely to remain in a wait and watch mode for longer.
FY14 was not so good for primary dealers (PDs) as the 10-year bond yield was quite volatile. Do you think FY15 will be better?
Yes, last year was a tough one from all perspectives. The volatility was high, the rise in yields was unprecedented and there was a funding squeeze for most part of the year. However, we did well last year and closed the year with the highest profits in the last five years. What helped us was our ability to use derivatives effectively, quick churning positions in bonds and capture intra year volatilities. From a business model perspective, a PD should not be dependent merely on an interest rate fall to make profits. Products should be available to enable PDs to capture rate moves on both sides. Although products like interest rate futures (IRFs) have made it better today, there is a lot of scope for improvement. Development of inter-bank repo market, higher cash bond shorting limit and allowing PDs to participate in currencies and commodities will go a long way in empowering the industry to withstand all kinds of rate environment. This year may be a better one than the last at least with respect to unforeseen volatility, but the responsibilities of underwriting a huge borrowing programme is always an undaunting task.
Do you think tax-free bond issuances will be announced for this financial year as well?
Tax-free bonds have enabled the retail and high networth investors to participate in the bond market in a big way. However, this has come at a huge cost as the effective pre-tax yield has distorted the entire interest rate structure and taxation structure. I think these issuances 50 basis points lower than G-secs are too expensive for the government and they need to have a re-look at the spreads and size.
We just saw one more year of below 5% Gross Domestic Product (GDP) growth. Do you see any improvement in this figure in the current fiscal?
The GDP story in FY14 was predominantly a contraction in industry, services remaining flat with respect to previous year growth while agriculture contributed positively and prevented a bigger disaster. On the expenditure side the positives were from consumption, net exports and the financing sub-segment due to the foreign currency non resident (banking) borrowing while contraction in investments was a concern.
On FY15 we expect GDP to be much higher than 5% with a modest increase in services and a fair rebound in industry but agriculture dragging it lower and net exports being flat. Political stability and implementation of stalled projects already cleared at close to 5% of GDP should help Industrial revival. Already, the growth in the electricity sub-segment has improved following govt. efforts, and that of mining and manufacturing sectors should improve as well.
Consumption growth may improve following good agriculture performance from the last fiscal. Better Industrial performance would reflect in improvement in key services segments such as construction, financing and trade, hotels etc. Growth improvement can be much sharper in FY16, when capacity utilization levels would have reached higher, facilitating stronger private capex. and inflation would likely be lower.
RBI has recently auctioned a new 14-year bond. According to you why was this done? When can we expect the new 10-year bond? What according to you may be the likely coupon of this bond?
RBI has an informal cap on the outstanding amount for each bond, considering the fact that lumpy redemptions on a single day in the future should not put undue pressure to the borrower as well as to the system. The outstanding on the two on-the-run 13-year bonds in the 10-14 year segment had already reached around Rs 90,000 crore which by historical standards was on the higher side.
This was the reason for the preference for the new issuance. Further the current total outstanding of all bonds maturing in FY29 was a very low Rs 11,000 crore. This explains the reason for the choice of maturity of the bond in that bucket. It may also be noted that the RBI has already auctioned a new 6 year bond very recently.
A new 10-year can come by the last week of June as the outstanding on the existing benchmark 10-year paper 8.83% 23 has already touched Rs 69,000 crore. It may be noted that the the previous benchmark 7.16 per cebt 2023 issuance was stopped at Rs 77,000 crore. Market is quite bullish post policy and in the current state of things, a new 10-year will be priced around 8.40% levels.
RBI for the first time did a term reverse repo. Do you see more of these term reverse repo auctions?
Due to the stated anti-inflationary stance, RBI would be uncomfortable with the overnight rate dipping substantially below the repo rate for significant period of time. The term reverse repo provides the central bank with an additional tool to drain out excess liquidity should the need arise. RBI has been releasing substantial amounts of liquidity in the system due to its spot intervention of the dollar in its quest to prevent the rupee from appreciating too far away from the Consumer Price Index (CPI) based Real Effective Exchange Rate (REER).
However, to seterilise the same in accordance with the anti-inflation stance they have been initiating sell-buy swaps and paying forwards. This effectively postpones the liquidity injection in to the future. However, there is a cost for this operation. The term reverse repo provides one more viable tool for sucking out liquidity directly in the money market and hence I expect the same to continue in the future.
The first term reverse repo auction was under-subscribed but it was not expected to be hugely successful when the liquidity deficit is high. System liquidity deficit is currently at around Rs 95,000 crore which is well below the Rs 1,30,000 crore being provided by RBI using a combination of Liquidity Adjustment Facility (LAF), term repo and export credit refinance. Liquidity deficit should hover in the Rs 90,000 – 1,10,000 crore range till first quarter advance tax outflow in mid-June.
Banks will use the term reverse repo window much more actively in the future should the liquidity deficit drops substantially and if call rate drops substantially below 8%. The introduction of term reverse repo perhaps also means that RBI is in no mood to reduce term repo amounts as liquidity builds up in the system. Perhaps they want both repo and reverse repo to be available but only of them will be utilised by the banking system in a big way depending upon whether the system is deficit or surplus.
RBI has announced a host of measures pertaining to liquidity including cutting the statutory liquidity ratio (SLR) limit. What does it mean for the markets?
The SLR cut signals RBI’s optimism that credit growth may pick up pace along with the economy and banks should prepare themselves for lending to the private sector. And this cut paves the way for banks to lend to productive sectors of the economy as and when the demand picks up.
RBI is in the process of unwinding the steps taken in July to arrest volatility. At the same time, we are seeing the rupee weakening again. What is your near-term view on the rupee?
On the global front, India seems to be in a sweet spot, both with the kind of mandate the government has received and its implications for policy making as well as with the kind of improvement we have seen in the macro-economic variables. India seems to be best prepared to attract capital flows amongst all the emerging economies. This would lead to a bullish bias in the currency going forward subject only to RBI's own comfort on the level of the rupee. Having said that, one still needs to keep an eye on trade deficit, particularly on gold and non-oil, non-gold imports, which contributed significantly to the low current account deficit (CAD) in FY14. RBI has undertaken many steps to ease the restrictions imposed in July, including those on gold imports, booking of forward contracts by importers, foreign exchange remittance, etc. But RBI is using this opportunity (the stability in the rupee) to build up reserves in a liquidity-neutral way, which has kept the rupee from appreciating beyond the 58-a-dollar level.
Foreign institutional investors (FIIs) invested a lot of funds in debt in May. Do you see this pace of FIIs investment in debt continuing in FY15?
The net FII investment in debt in the month of May was around Rs 20,000 crore, out of which G-secs accounted for Rs 15,000 crore, Rs 11,000 crore in corporate bonds, and redemption/sale of Rs 6,000 crore of T-bills (Treasury bills). Most of the flows were in one- or two-year maturity papers initiated to take advantage of the lower forward premiums on the back of an appreciating rupee. However, last week, the pressure resulting from RBI paying forward has resulted in the premia going up and reducing the attractiveness of FIIs to invest in short-end debt. FIIs may look to invest in longer tenor papers after this policy and the pace may increase if government announces concrete steps to rein in inflation and fiscal deficit. The new foreign portfolio investors (FPIs) guidelines will ease registration of new FII accounts and Raghuram Rajan has also indicated that talks with Euroclear are on to take G-secs to a global platform.
Volumes of IRFs have started picking up. Can we say that the regulators have been lucky for the third time by launching this product?
Personally speaking I would have preferred that the IRFs be designed based on deliverable basket of securities. However, the single bond cash settled product design has been introduced taking market feedback in to account. It is hence heartening to note that market participants have taken good interest in this product. The open Interest of 10-year IRF is in excess of Rs 2,000 crore. Extending the life of securities and initiating futures contracts on other points of the yield curve should help develop more interest in IRFs.
Do you think the government's borrowing for this fiscal may be slightly higher than what has been announced in the vote-on-account? Where do you see the fiscal deficit for FY15?
Tax revenue buoyancy assumption of 19% year-on-year growth is optimistic but Finance Minister may keep it unchanged for now pinning hopes on increased economic activity. Disinvestment revenue has been budgeted at Rs 50,000 crore which can go up if SUTTI, Hindustan Zinc and BALCO stake sales are expedited at current market levels.
New government has been making the right noises about changing the expenditure mix like shifting focus to more infrastructure spending and targeted subsidies. But it remains to be seen whether the Finance Minister will be able to achieve any curtailment in subsidies particularly, fuel and fertilizer, given that there are unpaid bills; fuel subsidies may come down on the back of appreciating rupee and government may revisit LPG subsidy (reduce to 9 cylinders). Finance Minister has himself written twice about fiscal consolidation and importance of fiscal discipline.
Therefore, it is unlikely he will go in for higher deficit and will more likely stick to the fiscal roadmap under Fiscal Responsibility and Budget Management (FRBM) Act. If not 4.1%, budgeted target may be revised slightly higher to 4.4% which translates to additional Rs 35,000 crore; This doesn’t necessarily mean extra borrowing as government may decide to draw down cash balances or fund part of it through t-bills.
