The RBI sounds hawkish but when it comes to action it is not so harsh. How do you read the central bank?
Our expectation is that the RBI will not do any more rate hikes. In the previous policy, they did mention that they are very focused on bringing inflation down. They think that their policy measures are taking effect; it’s going to be a slower move than probably anticipated earlier. We think there isn’t a need to raise the repo rate, but they will use other tools. OMO (open market operations) sales are one tool that they have spoken of in the latest policy. They have used ICRR (Incremental Cash Reserve Ratio) before; they’ll probably do a CRR hike if required, but they have increased the hurdle to increase the repo rate itself.
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What could be the ideal level that RBI may be thinking about for bond yields?
I think 7.50% on the 10-year bond looks like a level where bond yields will be fairly priced. Everybody will be comfortable. We don’t think bond yields will go anywhere close to 8%…7.50% is like a Goldilocks level where the RBI and market participants would all be comfortable and foreign investors might find it to be attractive enough for them to come in and invest in India. Even after the JP Morgan Index inclusion announcement, we didn’t see investments flow in immediately, though there’s a chunk of investors who are already set up as FPIs. The valuations were not attractive enough to draw in that inflow. At 7.50%, I think that might change.
The governor said the planned bond sales were based on domestic liquidity considerations. But given the local inflation risks and the way US bond yields have surged, could it have been a signal of discomfort?
I would tend to think so. The RBI is focusing on managing local market conditions and reducing the local liquidity surplus but also at the same time, they would want to continue to be hawkish and not allow the market to become so complacent and loosen financial conditions as a result. They want to keep conditions tight. They also categorically mentioned the 10-year yield versus the three-month T-bill rate, with that spread having become quite stable. I think the RBI found the opportunity to conduct these OMO sales where even if it takes market yields slightly higher, it’s still not going to be very destructive. It keeps market participants alert to the need to keep financial conditions tight.
By when you see bond sales happening and how much?
If we assess the liquidity profile, roundabout now is when the total core liquidity is at the highest level. Over the next two to three months, it will go down on its own. We expect the bond sales to start anytime. We think it will be something like two auctions a month, every alternate week, for a quantum of around ₹10,000 crore. The total size at this stage would be anywhere from ₹50,000 crore to ₹70,000 crore.Is the narrower rate differential with the US a deterrent to getting overseas funds into bonds?
What we understand is that the index followers will put money in the emerging markets, and they do focus on nominal yields. From that perspective, Indian yields are already at the higher end of the range. If the weighted average nominal yield of the index comes somewhere between 6.25-6.50% now and Indian bond yields are close to 7.25-7.50%, we already have that pickup. We are quite confident that the inflow will come.
What is the quantum of overseas investment you are expecting from the JP Morgan index inclusion?
We do think that the JP Morgan index inflow would be anywhere between $20 billion-25 billion based on the AUM following the index. We are looking for an opportunity where the non-index followers also find it attractive enough to come in. We think that the index followers will put India as overweight because of the nominal yield higher than average and also the stability of the rupee.
Which part of the sovereign bond yield curve would you favour at this juncture?
We like the longer end of the curve – the 30-year segment. For any long-term, passive investors, we would like to recommend that segment. The fundamental reasons for that are, firstly, India’s fiscal deficit trajectory is improving. Almost 40% of the entire stock of Indian government bonds is owned by insurance and pension funds, and their demand is rising at a level that is higher than the nominal growth rate – something like 15-20%. If you combine these two, in a couple of years, the demand is going to outstrip supply and we are at the higher end of the rate hiking cycle. The long end is going to be in really high demand.
