Diverse concerns over debt market

Unsustainable CAD, sticky inflation & impact on pace of rate cuts all worries for FY14

The current account deficit (CAD) in the country's balance of payments and the rate of price inflation will continue to worry the debt market in the next financial year (2013-14). Hence, the pace of rate cuts by the Reserve Bank of India (RBI) might be lower, expect experts.

They also feel we might continue to have tight liquidity for most of FY14, with the high government borrowing also a dampener. India's CAD for the second quarter ended September 2012 rose sharply to $22.3 billion from $18.9 bn in the same quarter a year before, due to a higher pace of imports and moderating export growth. As a proportion of gross domestic product (GDP), the CAD rose to an unsustainable 5.4 per cent for Q2 of FY13 from 4.2 per cent for the quarter in FY12. It is more than double what RBI considers sustainable (2.5 per cent of GDP) when the economy grows slowly.

After three months of decline, the wholesale price index-based inflation rose to 6.84 per cent in February from 6.62 per cent the previous month, reflecting the impact of fuel price corrections by the government.

“We need to keep a watch on price of oil because if that goes up then inflation will be imported through this oil price rise. The price of oil will also affect the CAD. RBI's stance on interest rates is another important factor influencing inflation,” said Brijesh Mehra, managing director and country head – international banking, The Royal Bank of Scotland N.V.

In FY13, RBI had cut the repo rate, at which banks borrow from it, by 100 basis points; it is currently at 7.5 per cent. The rate was brought down in three tranches and the last cut was made earlier this month in the mid-quarter review of the monetary policy.

However, RBI also said the room for further monetary easing remained limited. "The expectation is that of 50 basis points of rate cut, going forward, but we need more in today's slow economic growth. RBI is hesitant to reduce interest rates because the CAD is high, the rupee is depreciating and debt flows are a challenge, despite huge limits," said K Ramanathan, chief investment officer, ING Mutual Fund.

Experts say the CAD will lead to liquidity tightening. "Liquidity is of paramount importance. The CAD will be the major worry, which will cause liquidity to tighten," said Dwijendra Srivastava, head of fixed income, Sundaram Mutual Fund.

They say the other worry is the high government borrowing programme. It plans to borrow Rs 3.49 lakh crore in the first half (April-September) of FY14, compared with Rs 3.7 lakh crore in the first half of the current financial year.

A concern, say experts, as most of the bond maturities are also scheduled in August-September. Due to this, the net supply of government bonds will continue to be high in the April-July period of FY14.