Market veteran said that Reserve Bank of India The editing process has already started Ultra-loose monetary policy Through its business on the liquidity front. Accordingly, Prasana expects the policy rate corridor, currently at 65 basis points, to shrink to 25 basis points during the next two meetings of the Price Setting Committee of India.
With an unexpected rise in US retail inflation in October spurring talk of a faster pace of bond deleveraging and the possibility of monetary tightening, the dollar was largely on a strong spree. How do you see this happening in relation to the rupee? Where do you see it at the end of December?
With US economic activity returning to normal at a rapid pace after the vaccination, the Fed’s policy focus has rightly shifted toward rising inflation risks. In this context, the process of gradual normalization with gradual quantitative easing began. However, as higher inflation becomes more of a transient, the possibility of an accelerated path of normalization, both in terms of scaling back quantitative easing and rate policy, is well-founded. On the other hand, given the growing risk of renewed pandemic fear in Europe, the European Central Bank remains relatively pessimistic. This divergence in growth and monetary policy has created a supportive environment for the dollar and is likely to continue. However, the strength in the ex-Japan dollar/Asia is relatively weak as the growth differential still favors this part of the corridor and capital inflows are still supported. The rupee has also benefited in this general context, but given the increasing pressure on the foreign trade front, we expect the rupee to weaken towards 75.50 against the dollar by the end of December.
The Reserve Bank of India (RBI) reiterated that it will take a gradual, well-telegraphed approach when it comes to policy normalization. Opinions are divided on whether there will be a reverse repo rally in December. What are your expectations from politics? Do you think the main bank is in sync with other central banks when it comes to normalizing very loose policy?
RBI normalization must be viewed in the general context of the growth-inflation trade-off. With most key economic indicators normalizing to pre-Covid levels, the Reserve Bank of India (RBI) has begun to adjust to its very loose policy prescription – with liquidity normalizing through variable reverse repo auctions (VRRR) across periods and discontinuing GSAP. The rate cuts at VRRR auctions have already pushed the banking system’s overnight liquidity cost closer to the repo rate. Hence, the formalization of such a modification is very likely through a high rate of reverse repo. We expect the monetary policy range to narrow to 25 basis points over the next two policy sessions.
What is the road ahead for the government bond market? The fact that the RBI has opted not to conduct more OMOs since discontinuing the GSAP program indicates the central bank’s aversion to more permanent liquidity injections. How will the combination of tight liquidity and high rates affect the market? Which part of the yield curve would you recommend at the current juncture?
In an environment of global monetary policy normalization, upward pressure on the yield curve is expected to continue as market participants discover the extent of policy normalization in the wake of persistently high inflation. Moreover, a less benign fiscal regression trajectory indicates that the balance of supply and demand will continue to be challenged, and more so in an environment that is less directly supportive of the RBI through operations management processes. There is, however, a positive side, as IGBs are poised to join global bond indexes which could attract significant foreign inflows of real money into the sovereign bond market. Moreover, given the already significant risk premium that is priced in a steep sovereign yield curve, the belly (10-14 years) is likely to outperform the front end. In the near term, we believe flattening the curve is the most likely outcome.
The latest data on domestic inflation showed only a marginal rise in October, but many analysts warn that the CPI will rise to 6 percent in February and March 2022, especially as food prices continue to rise. Given this, what is your timeline for raising the repo rate?
Core CPI has moderated in recent months but core inflation remains flat. Moreover, the rising wedge between the PPI and the CPI indicates that the pass of higher producer prices is still in progress and to this extent there is an upward bias for CPI. Overall, the CPI trajectory appears to be heading towards the higher end of the MPC target range at 2%-6%. As far as the repo rate hike is concerned, we look forward to a change in the policy stance to neutral at the February policy meeting followed by the first repo rate hike in the first quarter of fiscal year 23.
From a growth perspective, it looks like we’ve seen a significant recovery since the second wave although the 20.5% growth for April-June has weakened the markets. Do you agree with the RBI’s 9.5% valuation for FY22? What are headwinds and tailwinds in your opinion?
We are quite optimistic about the overall growth scenario and expect FY22 growth to exceed 9.5%. Faster and broader vaccination coverage reduced the tail risk from the epidemic resulting in a sharper recovery in local mobility and economic indicators. Moreover, export performance during the current fiscal year has been a hallmark that is an additional tailwind to the entire growth narrative. From now on, even the investment cycle is likely to start in view of the sharp improvement in the balance sheets of companies and banks alike. However, there is a risk that high inflation could become more persistent, accelerating the pace of policy normalization across markets. Moreover, the risks from higher commodity prices and the re-emergence of infections must be carefully monitored.
Do we have a problem with having too much froth in the system which leads to mispricing in both the debt and equity markets? Could low real interest rates discourage foreign portfolio investors from investing as the world begins to tighten policy?
If you go by market pricing of policy prices derived from interest rate swaps or bond yields, there has been a lot of adjustment in the forward price path. However, there is still room for a higher adjustment in credit spreads which remain benign in the wake of corporate deleveraging and muting of demand for capital expenditures. As far as the stock markets are concerned, there has been variation in terms of how investors view the growth and value of stocks, not only in India but globally. But on an aggregate basis, due to recovery of corporate profits, de-leveraging and expansion of ownership through more domestic savings channeled to markets, there is limited downside to markets. As far as fixed income is concerned, India still offers better real-rate return for global investors. Moreover, due to the MPC system of inflation targeting which provides stability around the exchange rate, there is definitely a case for increased inflows of foreign portfolios in the bond market.
How confident are you that the government will achieve the fiscal deficit target for the current fiscal year? Are government revenues in a good enough position to rule out the possibility of any additional borrowing in the market?
Government revenue on the tax front is likely to be 3 trillion rupees more than budgeted revenue. A shortfall in the aggressive divestment target is more likely. However, on the non-tax front, the Reserve Bank of India has already provided above-budget earnings. Revenue recovery prompted the center to absorb the full shortfall in GST reimbursement for states which is another indication of the health of government funding despite the blow dealt by the reduction of excise tax on petroleum products and the extension of PM-GKAY until March 22nd. In general, we do not expect any additional market borrowing from the central government as the funding shortfall, if any, can be filled by cash withdrawals above the budget and borrowing from the National Social Security Fund.
The latest development was the re-emergence of the virus with a new mutation described as “Omicron”. What third effect would it have on all of what I described above?
This is the kind of press stop development we need to evaluate. It’s still very uncertain but things may become clear a bit soon. For now, the new “Omicron” boom is a real reminder that the epidemic is far from over. However, since the entire ecosystem has now learned how to deal with this epidemic, I would put this risk in the “known – unknown” category. It may take the greater part of the next two weeks for the medical fraternity to learn what the new surge means and the effectiveness of the current vaccination regimen. In the meantime, risk sentiment may subside as market participants and policy makers assess its severity. However, I am optimistic that the initial market reaction will return the way to a medium-term outlook which appears constructive for most of the asset class. As far as monetary policy is concerned, it reduces the possibility of accelerating the tapering schedule on which the market began to speculate. I don’t see this development changing the RBI’s action when reverse repo normalization begins in the next policy although views on REPO elevations could be subject to change.