If inflation doesn’t ease, RBI may start unwinding in Feb: Arun Srinivasan

Surplus liquidity and rate cuts are not sufficient to keep the market rates low for long given that inflation is rising, said the executive vice president – head of fixed income, at ICICI Prudential Life Insurance.

Excerpts:

With inflation going above target, what is the outlook for interest rates in terms of policy action?
I believe we are practically at the bottom of the interest rate cycle. In February 2021, the market could see an increase in reverse repo as a first sign of a changing interest rate stance. Any further interest rate cut from current levels is unlikely to push the credit growth. It is the risk aversion prevalent in the market that needs to change for reversing the sentiment.

Last week, we saw record devolvement of RBI benchmark bond auction. What did it signify?
The devolvement by RBI at aggressive levels is a positive affirmation that the central bank would come with its full might whenever it is required. Importantly, it instils confidence in the market that more measures can be expected from RBI if yields show signs of rising.

What is the worry for the market now despite all the rate cuts and surplus liquidity?
Market is keenly looking at how the government will fund its fiscal deficit for this financial year. The economy was anyway in a slowdown before the onslaught of the Covid pandemic. The lockdown has further worsened the domestic economy. It is broadly expected that the deficit from the GST revenue collection will be quite substantial for the year. Given this backdrop, the second half borrowing by the government will be the key determinant of the trajectory of bond yields from here on.

How do you see RBI’s latest liquidity measures and what more could it do?
RBI’s Held-To-Maturity move could increase demand for government bonds from banks. It can tinker with the Statutory Liquidity Ratio (SLR). While these measures would be helpful for the government to raise funds from the market, it will defeat the basic purpose of lending to businesses.

There seems to be a widening disparity between the state and central government bonds. Why are investors discriminating?
It is quite surprising that in the market today, the bonds of state governments including financially sound states such as Tamil Nadu, Telengana, and Kerala are trading at yields higher than the bonds of some of the top-rated public sector companies. State governments have limited sources of revenues in the light of the ongoing Covid pandemic. It is widely expected that the borrowing requirement of the states for this fiscal year will be huge. This concern is weighing on the yields that the market is demanding from the states. An open market operation by RBI for states, in line with central government bonds can lift the sentiment for state government bonds.

The system is flush with liquidity. Still the markets are not normal, Why?
Daily liquidity in the banking system is as high as Rs 6.16 lakh crore. While this surplus liquidity has helped all non-banking finance companies, primarily this liquidity has helped them with just their refinancing needs. Outside of these contours, any non-triple A rated company has to pay a higher funding cost in the market today. In the present market, a well-known NBFC which is rated AA+ still has to pay 13% for raising one-year money from the bond market, which is still substantially high given that we are at one of the historical lows on the RBI policy rate.

The RBI Governor has indicated at unwinding on a few occasions in the past month. How do you see it happening?
In my view, unwinding of the policies will begin with a narrowing of the corridor between the repo and reverse repo rates. This may begin from January or February next year, provided the pandemic is under control by that time and the economy is showing signs of a recovery.

Is 6 percent a new normal for the benchmark yield?
It could well be. Nothing is surprising in it, especially when the surplus liquidity is over Rs 6 lakh crore. More than the levels on the benchmark yield, I will look out for levels at the shorter end. I will be concerned only if the Treasury Bill rates surge 200 basis points higher than the overnight rates.

How many more 6 % plus readings will prompt RBI to raise rates?
In my view, RBI will wait for two more readings. Headline CPI (Consumer Price Indexed) for July was seen at 6.93%, much above market expectations. MPC may pause on policy rates but could change the stance to neutral from accommodative. By the end of the next two policies, RBI should have a clear picture on food inflation and how well the economy is faring.

The market appears to have taken the MPC minutes as quite hawkish. Was that so?
In my view, the market has interpreted the MPC and their stance correctly. Given the inflation print and the green-shoots in some sectors, some MPC members were a little hawkish, which weighed on the bond yields and dented the positive sentiment that had built up in the market. However, the MPC policy meeting is held every 45 days, so the market has ample opportunities to gauge the intent of the RBI going forward.