Bond yields have become volatile since July 15. Do you see them stabilising in the near term
We believe that yields have likely peaked out and will soften going forward. There has been a significant impact of monetary tightening by the RBI, with 10-year bond yields spiking from 7.5% to a peak of close to 9.5%. However, yields have subsequently fallen back to the 8.5% levels. This volatility was caused due to the unexpected RBI actions. We expect the market to incrementally focus on growth-inflation dynamics, which are very favourable for bonds.
How do you read the trajectory of interest rates in the year ahead
We do not expect RBI to increase policy rates further. Over the coming months growth and inflation are likely to dominate the RBI's agenda. With GDP growth at 10-year lows and inflation remaining under control despite the currency depreciation, we expect interest rates to be cut going forward. Similarly, bond yields, too, should fall in the months ahead.
What do you make of the measures initiated by the new RBI governor Raghuram Rajan
Rajan has outlined his key policy priorities for the near term. Given that a monetary policy statement is due shortly, he stayed away from making remarks on policy. However, his statement that the ultimate function of the RBI is to protect the purchasing power of the rupee through low inflation whether the source of inflation is domestic or through the exchange rate sets the tone for his monetary policy stance. In this context, it is important to note that, currently, imported inflation is low, thanks to weak global commodity prices. Despite the currency depreciation, we do not see evidence of imported inflation. Domestic inflation, as evidenced by core WPI inflation, is close to a multi-year low. This should give RBI room to ease policy in the coming months.
Do you see the rupee strengthening
History suggests the rupee strengthens when growth is strong. Conversely, low growth periods coincide with rupee fall. It appears that policies designed to promote growth also lead to currency strength. Of late, the government has been taking steps to improve the investment climate and has embarked on a reform path.
If RBI also participates with lower rates, we could well see a period of currency strength. However, in the near term, growth indicators such as PMI point to further slowdown. The rate hikes and liquidity tightening measures during the past couple of months also point to an extended slow patch for growth. In such an environment, it is possible that the rupee may not strengthen substantially.
How will the rupee depreciation and the food security Bill impact inflation
We have been fortunate that global commodities have been weak over the past year. Thus, even adjusted for the currency weakness, we see only a limited impact on inflation. Food inflation is a wholly domestic matter and the Food Security Bill may have some impact on food inflation. However, its impact may only be felt in the years ahead rather than in this financial year.