With Interest Rate Cycle Reaching The Bottom, Long Term Bond Issuance May Pick Up

Inflation has bottomed out leaving the Reserve Bank of India with less room to undertake further rate cuts, says India Ratings and Research. India Ratings believes that in such a scenario companies may lock in their long term funding at the current rates before the cycle turns.

The shift in RBI’s stance with respect to liquidity to neutral from deficit mode has had a significant impact on the government securities yields. Liquidity is no longer in the deficit mode, in fact in the last two months there has been a net liquidity surplus. The yield on the benchmark 10-year G-sec is presently hovering around 7 percent as against 7.5 percent in April 2016. India Ratings believes that the possibility for a further liquidity driven drop in the G-sec yield is limited. However, due to negative yields prevailing globally, demand from foreign participants can push yields down further.

One of the unstated objective of the outgoing RBI governor Raghuram Rajan was to maintain real interest rates (difference between risk free interest rate and consumer price inflation) positive and in the range of 1.5 to 2.0 percent. India Ratings expects the new RBI governor Urjit Patel to also follow this approach. Real interest rate has remained positive since January 2014. It peaked at 4.91 percent in November 2014 and has declined since then to 2.06 percent in August 2016. It may be noted that the period when the real rate of interest was significantly in excess of 2.0 percent was also the period when RBI cut the policy rates. As the real rate of interest fell close to/lower than 2.0 percent from April 2016 onwards, RBI has maintained a status quo on policy rates.

Inflation appears to have bottomed out, however inflationary expectations have once again shown an up-tick. The RBI carries out a quarterly survey of about 5,000 households across 16 cities in India to assess inflationary expectations of households three months ahead and one year ahead. As per data released by the central bank, mean household inflationary expectations for three months ahead in June 2016 rose by 110 basis points to 9.2 percent from the March 2016 survey. The one-year ahead mean inflation expectation is even higher at 9.6 percent than the three-month ahead expectations, implying households expect the inflation trajectory to move further up.

Though global factors particularly low interest rates and fund inflows into emerging markets have remained favourable for a fairly extended period of time, the likelihood of interest rates moving up from here has strengthened - notwithstanding the fact that the U.S. Federal Reserve may still take some time to resume hiking rates. With the backdrop of rising global yields, where global sovereign-bond yields have risen to the highest in almost three months, the Indian currency may come under pressure and push the RBI to turn hawkish.

Corporate India will be keenly monitoring the nominal GDP growth rate, since the soft trend over the last three years has significantly impacted earnings and debt repayment capacity. Ind-Ra highlighted in the report ‘Rs 1.4 Trillion Refinancing Requirement Could Put Rs 11.8 Trillion Debt at Risk in FY17’ that the total refinancing required by the top 500 corporates in FY17 aggregates to Rs 2.1 lakh crore, with potential candidates which will be able to access the bond market being Rs 70,000 crore. While it is early to signal a shift in the revenue trend line, corporates are likely to benefit from the current refinancing opportunities at low rates and will possibly lock-in long term funds since the downside to interest rates are limited/negligible.

(India Ratings and Research a wholly owned subsidiary of Fitch Group is a SEBI and RBI accredited credit rating agency operating in the Indian credit market.)