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BW Businessworld

What The Debt Market Foretells

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Mohan Shenoi, President – Group Treasury & Global Markets, Kotak Mahindra Bank and Phani Shankar, Head Financial Markets, ING Vysya Bank talk to BW's Tanushree Pillai about the trend in the debt and money market and a give their forecast for bond yields and the rupee.

Indian bond yields touched the psychological 9 per cent level and bounced back thereafter. What are the concerns in the bond market?
 
Shenoi: The biggest concern of the government securities market is excess supply which far outstrips demand. There's a steady input of Rs 13000 crore of dated securities every week plus Rs 7000 to 8000 crore of State Development Loan every fortnight, weekly treasury bills' auctions plus intermittent issuance of Cash Management Bills.

The market and primary dealer system do not have the appetite to underwrite and absorb such avalanche of supply of Government paper.

Shankar: The heavy supply has brought in growing concerns the government will overshoot its fiscal deficit target of 4.6 per cent of GDP. Persistently elevated inflation also continues to keep bonds under pressure.

Shenoi: Secondly, the banking system as a whole is maintaining statutory liquidity ratio at 29 to 30 per cent of their Net Demand and Time Liabilities (total deposits) as against the required level of 24 per cent. This has also dampened demand.

Some banks have also announced that they will move away from Government securities to ‘AAA'-rated corporate paper in order to improve their Net Interest Margins. This is putting pressure from the demand side.

What is the current trend in the overnight money market of collateralized lending and borrowing obligation (CBLO) and interbank call money market?
 
Shenoi: Liquidity in money markets continues to be in the negative territory. Average deficit at the system level is around Rs 50000 crore.

 Hence, money market will operate at the upper end of the interest rate corridor. In other words, repo rate will continue to be the operative rate. CBLO and call money rates therefore will hover around the repo rate.
 
How has trading been this past month in the overnight money market?
 
Shankar: Liquidity has been in deficit mode, but largely within RBI's comfort zone. Trading has been fairly stable with CBLO rates trading near repo rate while interbank call rate trading about 5-10 basis points above repo rate.

Shenoi: With liquidity in negative territory, trading in money markets has been negligible. 

What's your near-term and medium-term prediction for bond yields?

Shankar: In the near term, bond yields are expected to peak around 9%, but the bond market should pare losses in the medium term to trend towards 8.5 per cent as supply concerns ease, with likely Open Market Operations purchases by the RBI and inflation trajectory starting to ebb slowly.

Shenoi: The 10 year benchmark 7.80 per cent -2021 bond yield is expected to be around 8.75% to 8.85% in the next one month, while it may rise to 8.90 per cent - 8.95 per cent levels in the next three months.
 
All eyes are on RBIs October 25th policy. With 12 rate hikes in about 18 months, and  more expected, what are your expectations?
 
Shenoi: We expect another increase of 25 basis points in Repo rate and a concomitant increase in reverse repo rate. Inflation is yet to moderate forcing the RBI to continue its anti inflationary stance.

Shankar: We expect RBI to raise the repo rate by 25bps on 25th Oct as managing inflation remains the central bank's key concern.
 
Inflation for the month of September (at 9.72 per cent) remained much above the central bank's comfort zone and its efforts to rein it in have not had much impact. Where do you think is inflation headed in the medium-term and by March-end?

Shankar: Inflation trajectory is expected to start showing a downward trend in a months time. We expect inflation to be close to 7 per cent by March end.
 
Shenoi: Headline wholesale price index is expected to be at around 7 to 7.5 per cent by March 2012.
 
How is the demand for bonds and Treasury-bills currently and why?
 
Shenoi: As the SLR holding of the banking system remains significantly higher than what is mandated by RBI, the appetite for bonds and Treasury-bills has been very limited.

This limited appetite is manifesting itself into higher yields in successive auctions and devolvement in dated government securities auction.

Shankar:  The last two bond auctions clearly witnessed poor interest, with 2 out of 3 securities worth Rs 4038 crore on offer devolving last week, while in the previous week, securities worth Rs 899 crore devolved. Even Treasury-bill auctions have been witnessing higher yields than before.

Along with over supply and high inflation, there are growing concerns that after an extra borrowing worth Rs 52800 crore already being announced for the second half of this fiscal, government might need to increase its supply further towards the end of the year to meet its shortfall.
 
Where do you see the rupee headed in the next a) 1 month b) 3 months c) 6 months and why?
 
Shankar: Rupee is expected to trade between 48.50-51 per dollar in the next three months. With risk sentiments easing and markets being less vulnerable, we expect rupee to trend towards 47.50 per dollar in the next six months.

The movement in the domestic currency in the last few months has largely been driven by global factors as concerns of contagion risks in Eurozone threaten to destabilize the world economy. The rising risk aversion has led to drying up of foreign institutional inflows in India, with the net inflow being to the tune of USD 2.5 billion between April-October 2011 compared to USD 25 billion in the corresponding period last year. Not surprising, the Indian Rupee has weakened over 10% in the last six months.

Shenoi: I am expecting a weak Euro which means risk aversion in global markets. On account of that I am expecting INR depreciation 49.80 per dollar in the next one month, at 50.80 to 51 per dollar in the next three months and at 50.30-.50 in six months' time.