MSF still the operative rate for bond markets

Written by Aparna Iyer | Updated: Jan 10 2014, 09:32am hrs
Even as the Reserve Bank of India has indicated that the repo rate should be the operative rate for bond market participants, the Marginal Standing Facility (MSF) rate is still what decides the pricing curve, says Hitendra Dave, head of global markets at HSBC. Speaking to Aparna Iyer, Dave says that bond yields are unlikely to ease in a big way unless inflation falls sharply. Excerpts:

What is the effective rate that the market is working with, the MSF or the repo rate

I think the RBI has changed its stance now. When MSF had been hiked and liquidity tightened, it was in response to the exchange rate. But the RBI have moved from the reason for keeping liquidity tight from the rupee to inflation now. I think the cap on LAF would remain. The government balances and the currency with public will keep liquidity tight.

For all practical pricing purposes, the market is pricing everything assuming MSF rate is the operative rate. Otherwise why would the T-bill be at 8.70%

What is the outlook on the bond market

It would depend solely on inflation. The market needs to feel that these policy rates would ease. Otherwise, the best case policy rate scenario would be 8.75% and worst case would be 9-9.25%, which is what the view is right now. Eight out of 10 days, liquidity is going to be deficit. So my incremental cost is 8.75%, which is the MSF rate. Unless this is seen to be going down and data starts making people believe so, this is probably the lowest for bond yields. The benchmark bond yield may not go below 8.75%.

How much of an increase is expected in the borrowing programme of FY15

It is very difficult because there are elections, but it will definitely be more than the current year because the expenditure for the government just on interest payments has increased. At this juncture, almost everyone would be fearful of the mountain of supply that will come from April onwards.

Is there certainty that inflation will come down

It is a first time in many months that we are seeing a sharp fall in primary food inflation. We are expected to have bumper wheat output. But it would be too hasty to jump to a conclusion that one month of fall in vegetable prices are a fix to everything. In inflation, we need to see a trend. Vegetable prices appear to be under control, but we need to see it trickle into other products. Inflation situation is still under a flux.

If the correction in inflation is quite substantial, closer to 9% on CPI, the RBIs decision to not hike will be vindicated and credibility will go up.

Will the current stability in the rupee sustain

I think it can remain stable and it can actually outperform other currencies. But we need this pressure on gold, we need this pressure on coal imports to play out. People evaluate India as a macro story. So as long as inflation seems to come under control and fiscal deficit is reined in, some of the projects are genuinely getting addressed, we should have not problem. But all this cannot be a one-month wonder. There needs to be a trend.

Can we see sustained inflows after May, irrespective of the election mandate

In debt, inflows may come in if forward premiums are low and bond yields higher than the premiums. So debt does not have linkage with elections. In equities, if we get a decisive verdict and coupled with other fundamentals improve, then we could see sustained flows. The main issue is inflation as there is fear that it is becoming very entrenched. So if between now and May inflation comes down and current account shrinks, there is a strong story for inflows.

I would say that core issues of inflation, growth and deficits if these are in place, it will help even in adverse times.