'Current yields will lead to mark-to-market losses for banks'

Rate hikes will be something which we can expect when the borrowing programme comes down and economic growth prospects are strong, Nagarjan said

Rising bond yields over the past few days amid a surge in commodity prices have created a flutter across global financial markets, including India. MURTHY NAGARAJAN, head of fixed Income at Tata Mutual Fund tells Puneet Wadhwa in an interview that markets back home have been spooked due to announcement of variable repo rate auctions by RBI to suck out excess liquidity. Edited excerpts:

Has the sharp spike in bond yields taken markets by surprise?

Commodity prices have gone up and global yields have moved due to expectation of higher inflation going ahead. The Indian government has announced additional borrowing of Rs 80,000 crore for the current financial year and borrowing programme of Rs 12.80 trillion for the next financial year 2021-22 (FY22). The Reserve Bank of India (RBI) has decided to devolve the auction as they are not comfortable with the current yields. As primary dealers are leveraged, they sell the paper at lower levels to get rid of the stock. Banking system liquidity continues to be adequate and banks are flushed with funds. However, RBI intervention has been sporadic and they are not showing a commitment to defend levels, unlike the other central banks who are walking the talk.

What measures do you expect from the RBI over the next few months?

The market has been spooked due to announcement of variable repo rate auctions by RBI to suck out excess liquidity. This excess liquidity problem is due to RBI intervention in the forex markets and is constraining the central bank to do more OMOs. We expect the RBI to do more OMO during this financial year-end to protect the banks’ balance-sheet. Most central government borrowing has taken place when the 10-year yields was below 6 per cent. The current yields will lead to mark-to-market losses for the banks and deter them in supporting government’s huge borrowing programme.

Do you expect the RBI to hike key rates anytime soon?

Rate hikes will be difficult for RBI to do in this type of environment with consumer price inflation (CPI) within their target range. The government is trying to revive the economy, and has a heavy borrowing programme for FY22. Rate hikes will be something which we can expect when the borrowing programme comes down and economic growth prospects are strong. Rate hikes can happen only when we see consistent economic growth.

What has been your strategy given the recent developments?

We are still in a low growth environment and global markets are running ahead of fundamentals due to easy liquidity. We have been reducing our maturity across our schemes for the last two months. Investors need to be patient and expect accrual returns in high quality debt funds.

Are debt funds out of the woods yet?

The big players are getting stronger and consolidating at the expense of smaller and weaker players, who are losing market share. The credit quality of strong players are expected to be stable, but challenges remain for the weaker players.

To what extent are the markets pricing in a higher inflation and wider fiscal deficit?

In the last two weeks, markets have factored in higher inflation and wider fiscal deficit to a large extent. Globally, debt markets are supported by central banks. In the Indian context, this is happening in a piecemeal way, which is creating a flutter in the bond markets.

US treasury yields are rising at a time when there is inflation risk as well due to uptick in commodity prices. Do you see a more coordinated action by global central banks to check this?

Many central banks across the globe have been intervening in the forex and bond market to stabilise and aid growth impulse in the economy. Commodity prices going up – to some extent – is due to a weak dollar. Currently, most central banks are operating in silos, commodity exporting nations are benefiting from this development, which may make global coordination difficult.