‘Bond yields rising due to supply overhang’

Badri Nivas, India Head of Local Markets Treasury, Citibank NA, expects bond yields to continue to steepen on oversupply in the bond market. In an interview with BusinessLine , he said he expects the RBI to cut rates by 25 basis points in April and the rupee to continue depreciating given the weakness in emerging market currencies. Excerpts:

The yield on the 10-year government bond has seen a steady rise despite the RBI cutting rates by 125 bps over the last one year. What do you attribute this rise to?

Clearly, that is because of the supply overhang. Apart from the central bank issuances, we have seen a sharp increase in state borrowings.

Most issuances are in the long tenors, that is, 10-15 year segments. Further, there have been talks about discoms restructuring where possibly some of them are going to be replaced by bonds issued by state governments.

While the accounting rules on that are not yet finalised, there are still some risks that state bonds will also be coming into the market.

In a sense, it is becoming a tale of two curves.

If you look at the short end of the yield curve they are more anchored to the policy rates and that’s how they are likely to be. But on the long end of the yield curve that’s getting impacted more by the supply overhang and that’s where the steepness is playing out.

Do you expect the RBI to cut rates soon — maybe after the Budget?

We think that if the fiscal deficit number comes in as expected, then there is room for a possible 25 bps rate-cut in the April policy.

This would be in line with the RBI’s own forward guidance, where it said that if fiscal consolidation happens further there could be space for monetary easing.

What is the fiscal deficit number that you are looking at? Will the debt market react positively if the deficit is kept on the path laid down earlier?

Last year, we already pushed the fiscal consolidation by one year.

So, at a time when the economy is growing at over 7 per cent and you are not having a domestic crisis, pushing the deficit target of 3.5 per cent by another year may impact sentiments.

The key question also is the financing aspect — the biggest concern is who is going to finance the deficit.

Bond markets are already impacted by high supply and further fiscal expansion may cause yields to go up.

I think the RBI Governor, too, recently said that one should take cognisance of the bond markets. It is important for policymakers to ensure that the long end of the yield curve is not unhinged, given the demand-supply dynamics.

So, the present circumstances are such that we cannot afford to have a relaxation of the fiscal deficit.

What is your outlook on the rupee? Do you expect it to depreciate?

If you look at it from a medium-term perspective, our external fundamentals are still strong.

We expect the current account deficit to be around 1.1 per cent and the BoP (balance of payments) surplus to continue as long as oil prices remain low. However, in the global context of depreciating emerging market currencies, the rupee will not buck the trend. We are likely to see a guided depreciation of the rupee, especially given the RBI’s preference to boost foreign exchange reserves whenever you get large inflows.

In the short run however, portfolio flows have not been good and that has weighed down over the past few weeks.

For the downward pressure to ease, we need some reversal in global equity and risk sentiment or some positive surprises on the domestic policy front.

Why are we not seeing inflows when the macros are so good?

If you look at the last financial year versus the current one, we got almost $45 billion between April 2014 and March 2015 in portfolio flows and this financial year the number is negative $3 billion.

So the delta change is almost $48 billion, but the reason why the rupee has not further weakened and been on a bigger fall is because of the compensating benefit from lower oil prices.

If you look at the BoP surplus, last year was almost $60 billion plus, while this year, we expect it to be around $30 billion, still very large. So, when we talk about not seeing inflows, we have to look at it in the context that a lot of money came in the prior years.

One of the reasons why India is not seeing significant inflows recently is because global risk sentiments are very weak. Secondly, if you look at corporate performance in India, they have not necessarily kept pace with expectations.

Hopefully, if we take the right steps and see the benefits of that coming through in earnings uplift over the next financial year, then you will automatically get the flows returning.

It may take couple of quarters more before you see earnings pick up and a lot depends on the global scenario as well.

What is your expectation on inflation?

On inflation, what we see is that the next couple of prints should be lower. Recent data on food inflation, which are not yet reflected in the official numbers, indicate some softening. However, we do not see many structural factors that will bring inflation below 5 per cent on a sustained basis.

If at all, one-off factors like the Pay Commission or base effect wearing off on oil are likely to put upward pressure on the CPI. We don’t see it go much above 6 per cent, but it could be stuck in the mid-fives and, therefore, beyond 25 bps rate cut, we don’t see space for more monetary easing as of now.

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