By Ashutosh Khajuria
India's forex reserves have increased further by $2.7 billion to $414 billion. Indian rupee has strengthened by nearly 7 per cent year-on-year against the US dollar. With an adverse trade account that has further worsened in December, it is expected that intervention from the central bank would continue and so would be the accretion to forex reserves, thanks to the healthy inflows in capital account.
FDI alone has been in excess of $60 billion this year. Forex flows are expected to keep the rupee strong against US dollar despite intervention. The Davos meet of World Economic Forum witnessed a healthy outcome for Indian business akin to the interest evinced by WEF participants a decade back when our economy was growing at 9 per cent plus pace.
Let's now move on to the rates market. A statement from the Ministry of Finance about reduction in additional borrowing through dated securities from Rs 500 billion to Rs 200 billion has been welcomed by the market.
The regret has been that the additional borrowing of Rs 500 billion was announced on the eve of the quarterly results of the banks and other financial institutions that hold government securities and are required to "mark to market" their trading stock, while the curtailment in the issuance from Rs 500 billion to Rs 200 billion was announced at the quarter end.
Let's take stock of the impact of yield movement on the scheduled commercial banks alone. As per the latest Weekly Statistical Supplement (WSS) of RBI for the week ended January' 19, 2018, scheduled commercial banks were holding government securities to the extent of nearly Rs 34 trillion as at the fortnight ended January 5, 2018, which is about 29.5 per cent of their net demand and time liabilities (NDTL) of Rs 115 trillion.
Under the extant directions, banks may hold the SLR securities in their "Held to Maturity" (HTM) portfolio to the extent of the mandated SLR, presently, 19.5 per cent. The securities in HTM portfolio are not required to be marked to the market prices. The remaining portfolio is valued at the prevailing market price for arriving at the quarterly results.
Banks are holding nearly Rs 1 trillion of Treasury Bills, which are part of their SLR holdings but are carried at cost. With a large excess SLR holding even if it has low interest rate sensitivity (price variation with 1 per cent yield movement), the impact on the banks' balance sheets could be huge. Hence the timing of the official statements that impact the market price of Govt securities is very important and relevant for both, banks as investors and the government as issuer.
Apart from the investors, the statements or events resulting in northward movement of yield also impacts the fiscal deficit of the Government to the extent of rise in interest rate to be paid on subsequent issuances, not only in the current year but till the new issuances mature as these are fixed income securities and carry the same coupon that gets fixed at the time of auction till the security matures.
Indian interest rate derivatives market, unlike those in developed markets, is very thin and illiquid and does not provide the hedging solution to the holders.
Banks, therefore, need to reduce their excess SLR holding gradually and should work collectively to develop the derivatives market. Else, the market risk may add to the existing challenges being faced due to the credit risk part.
With reduction of Rs 300 billion in additional borrowing through dated securities and a very successful divestment program throughout the financial year that culminates into a large value resource generation through selling government stake in HPCL to another public sector behemoth ONGC at nearly Rs 370 billion in a fiscally challenged year, the worries of a major slippage on fiscal deficit budgetary target have started subsiding.
This may bring cheers to the bond market. In case the forthcoming budget presents a revised estimate of fiscal deficit at budgeted levels or, even 10 basis points more, together with fiscal deficit target of 3 per cent of GDP for FY 19, as envisaged earlier, the bond market may rally by 25 to 30 basis points.
The current spread between policy signalling rate (Repo rate at 6 per cent) and the Sovereign 10 year benchmark is about 140 basis points which normally quotes at 50-70 basis points in a neutral rate stance. Even if the rising inflation fears that have partly emanated due to higher oil prices, exist, it still throws up a short term opportunity for traders now that a large fiscal slippage worries have receded.
The coming fortnight is going to be very eventful for the markets. All the best to the market participants.
(Ashutosh Khajuria is ED and CFO of Federal Bank. Views are his own)