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3 reasons one should remain nervous on FX and bonds: Ananth Narayan

In an interview with ET Now, Ananth Narayan , money market e..

In an interview with ET Now, Ananth Narayan , money market expert, says , the uncertainty in the fiscal space, the commodity price and the global context, the question mark about bond yields and monetary policy will remain despite the relief you are seeing today.

Edited excerpts:

Bond yields have risen over 60 bps in the third quarter itself and the trend seems to be firm in Q4 as well so far. What is leading to the yield pressure? Is it more because of near-term liquidity and risk of fiscal slippage although that also should ease now because just a short while back, the DEA Secretary tweeted saying that the borrowing has now been brought down from the earlier Rs 50,000 crore to now Rs 20,000 crore.
His statement comes as a huge relief for the banking system today and you can see that reflected in the bond yields coming down initially by 20 bps. It has gone up a little bit after that. By way of a background, the big spike up in yields that we saw was around 27th of December when the government first announced that they will be borrowing additional Rs 50,000 crore this fiscal over and above their original budget. That has completely spooked the markets and that is when we saw 10-year yields which were hovering around 720 to 725 go up to about 740 or so. Then, yesterday we had the move on the back of the statement from the RBI that they would not be there to bail out banks in case of MTM losses.

The old 10-year bond go up to a high of 755 which is complete panic station. Some sanity clearly has returned now since the DEA's announcement.

A lot of this volatility could have been avoided because in the first place the market was expecting about Rs 25,000 crore of additional borrowing. But we initially announced Rs 50,000 crore and now we have come back to Rs 20,000 crore which was the original expectation anyway. But the broad problem still remains. The reality is we still do not have a full fix on how the fisc will point out. We have the budget coming up on 1st February and this is going to be an election budget with thrust on rural, with thrust on spending, with possible pressure on populism.

Secondly, commodity prices are not looking good. We did not expect oil to be crossing $70 a barrel and now there are fears it could be even higher. The big tailwind we had the last three-four years of low oil prices keeping the fisc and current account deficit down, suddenly seems to be disappearing. As you also mentioned, the global environment is looking pretty uncertain right now with Fed hike coming through and with the ECB talking about removal of QE.

All three things put together, the fiscal space, the commodity price and the global context, the question mark about bond yields and monetary policy will remain even going forward notwithstanding the relief you are seeing today.

There was not much clarity given on why this number has been reduced from Rs 50,000 crore to Rs 20,000 crore. While it is a relief and I completely agree with you on that, if the gap has been bridged by divestment, then that is a one-time income source. Are we looking at some sort of financial jugglery over here to meet the targets for FY18 but more for FY19 adjustment because it is going to be seen more as an election budget?
To be fair to the government, this is going to be a very uncertain time. Let us not forget that we are going through the implementation of GST. There is considerable confusion on what GST collections will look like net of refunds and that number is still unfolding.

The second reason for uncertainty is the nature of oil prices. Already over the last six months, we have seen a significant rise in crude prices. We know that while petrol and diesel prices at petrol pumps have gone up, they have not kept pace with the rise in international prices and let us not forget a few months back the government actually reduced excise on petrol so as to give some relief to the common man.

All of this means that the collections that the government is going to get and might flip over to some sort of subsidy, might be needed by the oil marketing companies and that will throw the fisc out of gear.

The last bit there is an acknowledgement that there is rural distress. Whether it is in the form minimum support prices which is of course more a state issue or whether it is more in terms of NREGA and doles for the rural sector, there will be spending which will come through. All of this makes the nature of accounting and math a little uncertain and this uncertainty will go on into the next budget as well.

FY19 is going to be no different. We have no clue where oil prices will finally settle. Nobody expected oil to cross $60. All the calculations we made about rig counts in the US and shale gas and all of that do not seem to be working out. If oil goes to $80 and $80 plus, then all the maths that we have made in terms of inflation, in terms of current account deficit, in terms of fiscal deficit will go out of the window and we will be looking at macro tailwinds of the past becoming macro headwinds.

Times are going to be uncertain and because of this uncertainty, notwithstanding the short-term relief the market has got today with the DEA announcement, we will remain pretty nervous both on the FX side as well as on the bond side. All one can hope is that the micro green shoots that we are seeing, good PMIs, nice IIP number, all of that will continue and given the global growth is looking good as well, maybe the micro growth will make up for some of the macro headwinds. But these are going to be uncertain times and banks will be especially nervous about taking on too much of interest rate risk at this point in time.

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