The managing director and CEO of India’s largest standalone primary dealership, however, believes that the invisible, and often visible, hand of the RBI will tide over the sovereign debt market even at a time when inflation is well above the central bank’s target.
“The RBI has been indicating, rightly so, that they are willing to be more patient even though inflation has gone up because this inflation does not seem to be demand-led. The central bank can react only to demand-led inflation.” Shailendra Jhingan, MD, CEO of ISEC PD, said in an interview. Edited excerpts of an interview:
Of late, there has been much speculation that the RBI is tolerating a rise in bond yields, perhaps to let pricing adjust to more realistic levels in keeping with elevated inflation and talk of global monetary policy tightening. In this backdrop, what is your view on the bond market?
I don’t think so. I think we can’t look at markets just from the prism of the 10-year bond. The narrative has evolved in a way where the movement of the 10-year bond is only considered, but, if one looks at it, yields on some other parts of the curve have moved up quite significantly. Even then, the 10-year bond has largely been range bound. Yields haven’t really moved much.
I don’t think the RBI is signalling anything like they are okay with higher yields. I think they are probably just letting markets express themselves. A 10-basis point movement here and there is not something that is meaningful from a monetary policy perspective.
The broader theme playing out right now in the market is that you have committed front-ended amounts for the open market operations through the G-SAP route. That support is very much there. Secondly, the support in terms of monetary policy is also there.
The RBI has been indicating, rightly so, that they are willing to be more patient even though inflation has gone up because this inflation does not seem to be demand-led. The central bank can react only to demand-led inflation. If the inflation is being led by disruptions of various types, then monetary policy tightening is not going to help solve the problem.
So, there is a commitment to open market purchases from the RBI and the support of easy monetary policy is also there.
All these positives are there, but then we also have to realise that the borrowing programme is also fairly large.
From FY20, the net supply of government bonds is almost 80% higher if one adds both central government bonds and state government bonds. Absorbing that becomes a challenge. And because it is all at the long-end of the curve, it makes it difficult for yields to come down because the supply overwhelms everything else.
But overall, I think RBI support is very much there and yields are likely to remain in a range for the time being till the effect of the pandemic on the economy has receded. So for the time being, at least for the next three to six months, I really don’t see yields moving either way too much.
The Governor recently emphasised that removing monetary policy support in an untimely way could negate the gains already made for the economy. But given that we also have a different approach from the Fed, which is talking about rate hikes in 2023 and a recent spike in oil prices, how long do you think the RBI can afford to carry on with an ultra-loose monetary policy?
Looking at the Fed, what changed in the June FOMC meeting was the consensus of dot plots – the majority hinted at 2 hikes in 2023. It probably does not reflect the views of the leadership group of the FOMC members. And that is the point which comes out even when you see the recent testimony by Powell where he said that inflation is transitory and that the Fed is still away from the goal of full employment.
Here is a developed economy like the US where the expectation is that this year’s growth will be 7.4% on the back of marginal negative growth last year. And here we have India where the GDP fell 7.3% last year and is seen growing 9.5% this year.
So in terms of their goals, in terms of growth coming back, the USA is in a far better position and yet the Fed Chair seems to be highlighting that they are willing to be patient. India is still far away. Of course, there are talks that the output gap would have closed by the end of the year, but I think still a lot needs to be done in terms of healing the economy. That is why the RBI is going to be patient.
Of course, what comes to our minds is the experience which India had the last time when the Fed hinted at tapering asset purchases and a taper tantrum happened in 2013-14. But I think what is different this time is that the degrees of freedom for the RBI to maintain easy policy are significantly more. Why I say that is firstly, we have over $600 billion of foreign reserves and the RBI has $50 billion of forward dollars as well. So you have almost $650 billion of reserves.
Secondly, the current account deficit is a lot better behaved this time around. Last time, it had crossed 4% of GDP. That becomes very difficult to finance. A wide CAD means you have to continuously attract capital and monetary policy gets dictated more by what is happening in USA or the rest of the world.
But, because we have reserves, because our CAD is low, I think the degrees of freedom to run accommodative policy even in the face of some kind of reversal in the US and elsewhere is a lot more.
We see that the central banks which are reversing quickly, like Russia, Brazil, Mexico or Hungary are doing it for currency reasons. Currency stability is more important over there. The central banks which have more degree of freedom like the RBI will be a little more patient even in the face of reversing US monetary policy.
Which segment of the market would you recommend at the present juncture? We have seen a bit of a selloff in short-term government bonds over the last couple of months because of the sudden surge in inflation and the likelihood of the extra GST borrowing being packed in that segment. Where would you say the value lies?
We still like the up-to-5-year segment because that is a pure play on the monetary policy and the supply risks do not manifest there. 7-8 year securities also do make a lot of sense. Essentially, we like the short-end of the curve. The 10-year bond is likely to be range-bound. You could take a 6-6.20% kind of a range.
How are you viewing corporate bonds at the present moment? A lot of companies have not seen much expansion in balance sheets.
The bigger theme playing out over there is one of deleveraging. To some extent, it is reminiscent of what had happened in 2003-04. Corporate India is deleveraging in a big way and that means that the supply of paper is very limited. So last year when the pandemic started, TLTROs came and the supply had picked up but that was more of precautionary demand.
But, ever since, we have seen that most of the corporates, at least the bigger ones, have been paring down their debt and we had seen such an environment in 2003-04, when banks’ balance sheets got cleaned up and corporates really reduced their debt levels. So, we are seeing a replay of that and in such an environment, spreads remain very narrow. Today, we have some AA borrowers borrowing in manufacturing at sub-6% levels.
So, that shows that the supply of paper is extremely limited and spreads are likely to remain low. From an investment perspective, the AAA corporate bond curve at various points is 20-30 basis points below even the SDL curve. And SDL being a sovereign asset, we would prefer to hold that rather than have too big a risk on corporate bonds today.
I don’t think that yields are going to change much. We are going to see spreads remain low till we see a meaningful pickup in the growth cycle and investment demand in the broader corporate sector coming back. So, I think spreads are likely to remain low.
As the country’s largest standalone primary dealer, how difficult has it been to handle the large-scale devolvements at government bond auctions so far this year?
The environment has been challenging. Devolvement comes into play for primary dealers only if you underwrite. I think you have to underwrite selectively in parts where you’re sure about the demand. In the long bond segment, even though yields have been moving up, the demand has been there even in the face of higher supply. The demand has been there for 15-year bonds and FRBs.
All said and done, the RBI’s support has been there for the market. It’s not like because the devolvements are happening the primary dealers are in trouble. It merely means that there’s a lot of volatility in our position sizes because suddenly devolvements come up and risk goes up. That needs to be factored in. The general impression is that when devolvements happen, yields tend to move up but that hasn’t been the case for some time.
The RBI recently notified the details of retail participation in government bonds. It’s very early days yet, to what extent do you think this could attract meaningful investment?
The retail product per se, the conception of it has been very good. At least from the RBI’s end, they have conceived the product well and it’s now fairly easy for a retail person to start buying gilts. Now the problem is that is it going to lead to a widespread demand when you have mutual funds as more tax-efficient ways of holding gilts? Or, for that matter, the small savings schemes which are absolutely tax free and offer a higher return. Yes, it will pick up, but for a broader participation there will need to be some kind of tax incentives.
From a platform perspective, however, it is as good as any and we wish that it will attract investors and it will ease the load on the borrowing programme.
What about the recent chatter on Indian bonds being listed on global indices? Would that be a game-changer as far as bond demand-supply dynamics are concerned?
Index inclusion will definitely be helpful. I guess it is still three months or six months away. When it happens it will lead to more passive flows coming in. But it could be challenging when the monetary policy cycles are reversing in a meaningful way at some stage, maybe one or two years down the line. Because at such stages, emerging market funds do see outflows. But initially, we would expect flows to come in and that should ease the supply burden on the markets.
