As inflation goes up, liquidity tightens and the outlook for the US improves, India will need to play a fine balancing act to keep its house in order, says K Harihar, FirstRand Bank. Excerpts from an interview with ETNow.
ET Now: How do you see bond yields shaping up over the next three odd months? Because the rise seems to be absolutely unabating.
K Harihar: After touching a low of about 1.56 per cent in July, inflation seems to have shot all the way up to 4.88 per cent. Part of it has been the result of base effect. But the number is 4.88 per cent, and we expect the next reading to even test the 5 per cent level. So that has been one factor, which is pushing up yields.
Liquidity in the system was in surplus to a large extent from November last year, but yesterday and day before it actually turned into a deficit. We are ending up borrowing from the Reserve Bank of India on an overnight basis. That is the second factor making the market jumpy. Then, of course, there are global factors.
The Fed has hiked interest rates and signalled three more hikes. The US tax plan has come out. While it is good for the US companies, and maybe for the US economy, it is leading to a situation where people believe if there is an increase in deficit, then interest rates in the US may go up. That is being reflected in the 10-year yields going up 2.48 per cent.
A spike in crude prices has been pressuring the rupee. Inflation has been going up. Liquidity has tightened and of course the lingering worry that we still have about overshooting that will happen in this year's budget – all of that have confluence.
Going forward, I am probably split in two ways; the course in next two-three months will be determined more by liquidity, because a whole lot of negatives have actually got baked into yields. If the liquidity situation eases off some bit, you will see the yields come off. We all know the base effect as it has pushed up inflation this year. Give three-four months and the base effect itself will actually push the yields down. So maybe, we are getting towards the top, but we can definitely test the 7.4 level. The backing off can happen if FIIs come in a big way, if more space gets allotted to them and if inflation starts to taper off.
ET Now: Do you think we have already seen very strong flows into Indian debt so far? Do you expect the trend to continue in 2018 as well, because the foreign limits are pretty much exhausted there?
K Harihar: Yes, that is going to be the biggest challenge. Because if we take 2017 as a benchmark, we had about Rs 1,86,000 crore coming into the market, out of which about Rs 1,35,000-1,38,000 crore actually came into the debt market. So the appetite for Indian paper -both government and non-government – is very high and the carry-trade – as it is called borrowing in dollars and putting in rupees – is going to be very valid. Also from the reason you mentioned earlier, the rupee has been very steady against the dollar and we do not see the dollar index go anywhere.
The regulatory space is not there. I am sure the case is slowly building up if you do not want the yields pick up in the G-sec market to percolate down in a big way into the corporate bond market and thereby impact the corporate growth.
There could be a slow case building up for having a special enhancement of FII limits to invest in both Gsec as well as non-Gsec. That is the only way you can immediately achieve a cooling off in yields.
ET Now: We also did see the rupee hitting a fresh three-month high this week. What is your view on the rupee for 2018? Do you see a further strengthening of the rupee?
K Harihar: Yes, I would tend to think so. Because even though trade deficit has actually gone up from $9 billion, which stood at $12 to $14 billion a month a few months back and all verticals are going up – be it oil, gold or non-gold – if I take the balance of payments, we are still good because FDI flows have been substantial. You do have the sporadic one-time slide in QIPs like those of the HDFC Bank and HDFC, which gets a lot of money from abroad. So there is a little bit of steadiness there.
The dollar index seems to be very lethargic in terms of its ability to take out the higher levels at 94 to 95. In that context, the macros are still looking up for India. Forex reserves are looking stronger whenever the rupee is going towards the 94 level. Importers really are not jumping in and trying to cover their exposure.
Exporters are coming in at every level, trying to lock into the forward premium. So our sense is that 64 will be a firm support. Even if it goes below it will come and bounce back. There seems to be a shortfall in rupee liquidity. So 64 on the left may be guarded a little bit, but fundamentally, it should look to breach the 64 level. In the coming year, we it will probably see more FII flows into equities, and then there will be FII flows into the debt market.
ET Now: What is your call on commodity prices? If they have to pass on the price rise, like Hero is doing, Maruti told us it is increasing prices from 2018 because of commodity prices, do you think these is a risk for corporate profitability?
K Harihar: There will be a risk for corporate profitability if companies are unable to pass it on. But we already see a lot of headlines. A number of auto companies are planning 3-5 per cent hikes in car prices starting January. To that extent, if steel and rubber prices all go up, you will see a pass through. Some part of it will be kept back by companies, but some part will definitely get passed on. So there is a risk to corporate profitability.
There is also a risk, partly to inflation numbers, because as the pass-through happens, and the items in which the price hikes happen form part of your inflation basket, then you could see an uptick in the prices. Separately, of course, you also have the balancing act to be done where in case you need to give up further push to 'Make in India' then you have to put in the customs walls, which to a certain extent, will enhance the cost of imported products and, therefore, have a similar kind of impact on the locally manufactured goods. So it is a fine balancing act that you probably have to ride out the space, where there might be an uptick in prices when sales offtake is happening.
We should look at it from a broader perspective and say that this could eventually lead to a hike in GST revenues for the government and we will be able to come back, manage the fiscal deficit and then through that come and manage the current account deficit.
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