In the wake of Covid-19, the bond market is facing significant stress in recent times while the rupee has taken a hit led by FPI outflows. Ananth Narayan, professor-finance at SPJIMR, tells Bhavik Nair in an interview that credit and fixed income markets are strained and need help. Excerpts:
1. What are your view on the measures taken by the RBI so far?
The RBI has an immense capacity to control both the currency and the fixed income markets. On the currency front, we have seen very large dollar demand this month, including record FPI outflow of $14 billion. In this background, RBI has managed volatility very well, by dipping into its ample currency reserves.
However, credit and fixed-income markets are strained and need help. Amidst FPI and domestic mutual fund redemptions, risk aversion, and market illiquidity, we’re seeing even quasi-sovereign short-term paper being dealt at 9%. Sustained dislocation of this kind can impair financial stability, at a time when financial services ecosystem is quite stressed.
2. How much time do you think the corporate bond market will take to recover?
Our corporate bond secondary market volumes are low compared to the holdings of institutional players. When institutions face large redemptions, we do see sharp dislocations unrelated to fundamentals. For now, this dislocation can be addressed by the RBI. First, the MPC might have to deliver a deep rate cut and undertake bond purchases, to give some relief to financial institutions. Next, the RBI may have to use the 2008 playbook and provide liquidity to MFs/ NBFCs against corporate bonds. Finally, banks can be nudged to be more active in credit markets.
3. Is the pain over for the rupee or are we going to see further depreciation?
First, rupee has been overvalued in real effective rate terms for a while now. Some amount of depreciation is good for our terms of trade. Second, the dollar itself has strengthened a fair bit against most currencies in recent times. Our permanent flows – across current account deficit (CAD) and foreign direct investment (FDI) – are now a comfortable surplus, for now. The dollar outflows we are seeing now are a risk-off reversal of portfolio flows, and of nervous open positions. There still is an overhang of open, unhedged positions in the market. For now, given ample currency reserves and surplus permanent flows, I think RBI will continue with what they’re doing – control volatility, but not come in the way of gradual, corrective rupee depreciation over time, if the outflows sustain.
4. Will FPIs think of looking at the Indian capital markets anytime soon? How long do you think the risk aversion will continue?
India enjoys a fair amount of goodwill among global investors. Despite all our challenges, we also enjoy some tailwinds – low crude oil prices, and the opportunity to onshore supply chains in the evolving global context. For now, global markets are on edge, and short-term investor behaviour can be difficult to predict. Medium term, with the Federal Reserve and the US government cranking out a huge combined monetary and fiscal stimulus, risk and liquidity should return sooner rather than later. At that point, the ball will be in our court.
5. What do you expect from the upcoming monetary policy?
In the current context, I would expect the MPC to deliver a deep rate cut – at least 50 bps, perhaps as much as 100 bps – more as a means of delivering relief, than achieving anything immediate on growth or inflation. While monetary print and fiscal spend may be inevitable in the short term, we are not the USA to continue with this forever. More medium term, we will require deep reforms to address the structural issues in our economy, and to take advantage of our many opportunities. In this evolving context, our MPC will have quite a challenging tightrope to walk.
6. How do you see the first-half borrowing by the government for FY21?
The Covid-19 lockdown will impact the economy, and overall demand will see a shock drop. This will hurt businesses and livelihoods. Only 17% of our workforce is salaried while the others are casual, contract and self-employed. A fiscal relief package will be inevitable to combat the challenges of Covid-19 and the lockdown, at a time when tax collections will also slump. In light of this, FRBM will almost certainly have to be set aside, and the borrowing by the government and public sector will rise sharply. In turn, the RBI may have no choice but to monetise much of this deficit by way of open market purchase of bonds.