Grumbling Bonds, Moody Rupee: The Signals Within The Noise
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Grumbling Bonds, Moody Rupee: The Signals Within The Noise

Are bond yields headed higher? Or will the Reserve Bank of India prevail and keep them down? Will the rupee weaken further? Is that a good thing? What‘s the bigger concern — growth or inflation?

The financial markets are swirling with questions as uncertainties over the direction of the local and global economy combined with a whole new world of policy actions that central banks are undertaking.

BloombergQuint put some of these questions to two veterans of the Indian financial markets — Hitendra Dave, head of global banking and markets at HSBC, and Jayesh Mehta, country treasurer at Bank of America. Here’s how they see the debate around bonds, the currency and India’s macros.

Why The RBI-Bond Market Stand-Off?

Since the union budget, bond yields have trended higher in response to the large supply of government borrowings. With demand unchanged or maybe even lower as the economy picks up, yields should move up, said one school of thought. The RBI, however, had continued to stomp down yields by intervening, most recently using its G-SAP bond purchase programme.

Mehta said against the backdrop of inflation targeting, the market is focussed on headline inflation, which is moving higher, even if it supply-side driven. But the RBI, just like other global central banks, will step in to support the markets.

When the yields start going up, you can’t define where it will stop. The damage it can do for other parts of market like corporate lending can be wider... There are some issues with targeting only the benchmark but now they have started looking at the five-year, 14-year and eventually they will have to look across all securities.
Jayesh Mehta, Treasurer, Bank of America

According to Dave, the RBI is conscious of the fact that the economy cannot afford higher rates at this point. The idea, Dave said, is to keep rates low in other segments, such as mortgages, which feed into demand for construction, creates employment and so on.

The reality of financial markets is that they can get unhinged from fundamental factors. Can we as a country, given the kind of growth challenges we saw last year, afford for that to happen simply to appease purists who think the market should be left alone?
Hitendra Dave, Head - Global Banking, HSBC

Is G-SAP The Start Of QE?

Under the G-SAP 1.0 programme announced to support bond markets, the RBI has committed to buying Rs 1 lakh crore in bonds in the April-June quarter, with most market participants expecting similar purchases over coming quarters.

Is this India’s version of quantitative easing?

They are simply trying to become more predictable, said Dave,

They are telling everyone that this is how much we are going to buy in this quarter... They are trying to address the demand-supply issue. We can over-intellectualise this and ask ‘is this QE’? U.S. QE is our OMO and our OMO is their Q.E. There is no real difference. All central banks have tried to address this demand-supply imbalance.
Hitendra Dave, Head - Global Banking & Markets, HSBC

Dave said the Indian central bank has, in fact, been very conservative about supporting the government borrowing programme. “That’s the price we pay for being an emerging market and not a reserve currency. The reality is that in the global context, the Indian central bank has been conservative compared to western and even some Asian central banks.”

Mehta agreed.

They (RBI) are doing their every bit to convince the market that we are going to support the market... We are actually being quite conservative. If we really look at it, we can go out and support much more because 95% of our government borrowings are local. And if they need to buy more, they will do that.
Jayesh Mehta, Treasurer, Bank of America

Shift In Thinking Of Sovereigns, Central Banks

According to Dave, there has been a clear thinking on growth globally, where sovereigns realise that they have to take responsibility for growth. Whether it is rural employment guarantee in India, cheques handed out in the U.S. or salary support plans in the U.K., governments are taking charge of reviving growth and in an equitable manner.

Naturally, all this will mean that governments will have to borrow more and central banks are stepping in to support them. This is a joint plan and financial markets have been a little slow to catch-up on this, Dave said.

Citing comments from former RBI Governor YV Reddy, Mehta said in crisis times, central banks have to work with the government. And that’s what every central bank is doing.

Rupee Falls: Fundamentals Or Carry Trade Unwinding?

Alongside the bond markets, the central bank has also kept the currency markets on a tight leash. Last year, the central bank absorbed dollar inflows worth $100 billion to prevent a sudden appreciation in the rupee. It intervened both in the spot and forwards market.

April, though, has seen the rupee depreciate making it the worst-performing currency in Asia. What’s changed?

A lot of people had carry trades offshore... The external trade numbers are changing significantly and the market is now adjusting to that. It has nothing to do with QE... It’s just that people build up positions at different times but unwinding will happen across markets at the same time. Now, it depends on what happens to FPI flows.
Jayesh Mehta, Treasurer, Bank of America

While the fundamentals of the currency will change this year given the higher oil prices and the likely return to a current account deficit, “it would take a very pessimistic person to assume that the external sector is a source of risk in India right now”, said Dave.

Whether it is in terms of month of imports, reserves to external indebtedness, or the size of reserves itself of nearly $670 billion, if you include forward positions, India is very comfortable. The central bank will control the currency the way it wants to. It didn’t let it appreciate last year. If it doesn’t want it to depreciate this year, it can step in. The jury is out but by empirical observation one senses that they don’t mind little bit of periodic weakness as long as it doesn’t get unhinged.
Hitendra Dave, Head - Global Banking & Markets, HSBC

Global Bond Index Listing: What Impact?

Markets are also watching for a likely inclusion of India in a global bond index. Will this improve demand for local bonds and help the bridge the gap with supply?

According to Dave, such a listing may not make a material difference to the supply-demand imbalance in the Indian bond markets.

I would rather use this phase when we are testing demand-supply imbalances materially to really relook at the structure of the fixed income market. You can’t have 40-50 or 100 people at best take this level of supply every Friday... You can’t have $3-4 billion of issuance every week with such a narrow base. That will not change with greater opening up to foreign investors.
Hitendra Dave, Head - Global Banking & Markets, HSBC

“In bullish times, it will be a great thing but in the current environment we should expect neutral outcomes from any global bond index listing,” Dave said.

Mehta agreed.

The widening of the bond investor base will truly only happen if deposit rates fall. One good thing is that insurance companies are becoming bigger but it will still take some time.
Jayesh Mehta, Treasurer, Bank of America

Watch the full conversation below:

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