As the markets prepare for the outcome of the two-day Monetary Policy Committee meet on August 7, SAURABH BHATIA, Head of Fixed Income, DSP Mutual Fund tells Nikita Vashisht that fiscal deficit, current account deficit (CAD), inflation, growth and global outlook point towards a softer interest rate regime going ahead and he expects two rate cuts during the current fiscal. Edited excerpts:
What are your expectations from the Reserve Bank of India’s (RBI’s) meet this week?
Larger movements in yields are determined on the basis of the expectations of further moves in repo rate and intent of government to maintain fiscal discipline. This combination has worked over the past few months as evidenced in the steep fall in yields. Steep vertical movements often discount further rate actions or factor macro data and then these moves tend to take rest as markets buy time to confirm the data. This could be in the form of consolidation at certain levels or bouts of profit booking which can seed intermittent volatility. As things stand, macroeconomic data indicates repo rates to head lower and hence softening trend will percolate into market yields as well.
How long do you think the rate cut cycle will last? Also, how much of a rate cut, if any, are markets expecting in August and in FY20?
Inflation is largely influenced by demand. In times when growth outlook is slower and capacities are underutilised, sustainable demand would remain low negating upside risks to inflation. Revival of growth is a by-product when problems of cost of money as well availability of money are addressed. Whilst we are in the process of addressing the cost of money, sustainable surplus liquidity will gradually aid to address the problem of availability of money.
With reference to the interest rate cycle, we analyse the outlook on rates basis key factors of macro stability. This includes fiscal deficit, current account deficit (CAD), inflation, growth and global outlook. All these five factors remain favourable for interest rates to head lower. We expect two rate cuts during the remaining part of this fiscal.
How do you evaluate government's decision to borrow in foreign currency? Will the forex reserve provide enough cushion to any downside risk to INR?
It is indeed a welcome step to augment sources of avenues to fund fiscal deficit. That said, there is a strong inherent demand for government bonds. End investor segment constituting insurance companies, retirement trusts, pension funds, etc already have a huge corpus and these entities are growing at 15% – 20% YoY. This demand coupled with statutory demand from banks helps to sustain inherent demand to fund fiscal deficit.
We expect the announcement of offshore borrowing as an enabler to augment the strong existing base of domestic investors. However, this route is likely to be used sparingly. The RBI has often demonstrated that the flows from the one off borrowings from offshore markets (FCNR, USD/INR Swaps) have been used to shore up foreign exchange reserves. This is likely to continue, thereby providing some cushion for downside risks to INR.
What are your expectations from Q1 GDP (gross domestic product) numbers? When do you think the economy might see a turnaround?
We expect GDP numbers to remain benign through the next two quarters. Growth turnaround can be materialised through a fiscal fed fast-tracked growth. This type of growth turnaround reflects higher fiscal deficit (hence higher interest rates), higher CAD (hence weakening pressure on currency) thereby stoking inflation. Herein, the RBI tends to maintain tight liquidity conditions to wane off imminent inflationary pressures. This model of growth decreases immunity of economy making it more vulnerable to global shocks.
On the other hand, growth can also be materialised by keeping macro stability intact; as disciplined fiscal approach will help to keep interest rates benign and allow RBI to maintain easier liquidity conditions. This model seeds sustainable growth momentum, and more importantly, allows the mantle to pass from public investment to private investments. We seem to have adopted the latter model of growth and expect this process to show results in first quarter of next fiscal.
Was the Budget too cautious with regards to the fiscal or current account situation? Do you think the government could have provided more stimulus to the economy?
Budget numbers indeed look challenging to achieve. We leave that to the government and its policy-makers and revisit the same closer to the next budget. Whilst the noise on feasibility of budget numbers and risks on sovereign borrowing would persist in the near term, the budget outcome has certainly eased the job for RBI MPC to ease further on rates and aid monetary transmission. Prospects of rate cuts aids bond markets whilst monetary transmission as and when it gets effective will aid growth, and hence the equity markets. The latter will move with a lag as process of broad-basing lower cost of money is underway.