Foreign Portfolio Investors have sold around $4.6 billion worth of bonds in 2018 so far as money moves to the US markets. Pradeep Khanna, MD & head of trading at HSBC, tells Tushar Goenka he doesn’t expect a substantial increase in FPI flows into Indian debt now given investors have more attractive choices. Excerpts:
Bonds yields have moved up sharply, where do you feel they are headed?
Government bond yields have moved up thanks to the global backdrop of higher yields. In addition, crude oil prices have been going up, a bad sign for India from a CAD and inflation perspective. I think the market panicked a bit when Brent crossed the $75 mark started factoring in situations where it could cross $80 or $90. Right now, local bank appetite to hold bonds on a mark to market basis has reduced since they are already stressed as a result of NPA provisioning. Many banks hold bonds in excess of statutory requirements and the rising yield environment has meant that they have had to bear mark to market losses on their bond portfolios. Till such time as there are clear indications that interest rates are headed lower, there will be very little appetite from local banks to increase bond holdings. This has been a contributory factor to the rise in bond yields.
Do you see Brent crude breaching the $100-mark?
A lot of research suggests we may move back towards $65/barrel in 2019 and I do not see Brent crude breaching the $100-mark. There is realisation even from oil producers that a short-term gain and a long-term pain will be a problem for them too. As the MPC has noted there is a high degree of upside and downside uncertainty around the price of crude, but the sense that I am getting is that it will consolidate around the $70-80-mark for now.
How do you view the rate hike by the Monetary Policy Committee? Has this led to higher bond yields?
I feel that a 25-bps hike was expected and is understandable. What surprised me the most is the outlook remaining at neutral instead of moving to a tightening bias. I think this means that the MPC has chosen to watch for developments in the monsoons, in MSP implementation and to keep an eye on crude prices. There is an ECB meeting and an OPEC meeting lined up this month which will provide some inputs. Based on the developments the MPC will take a call if a change in outlook is warranted.
Given the rate hike was expected I do not see this as a big driver of higher bond yields. In fact 10 year bond yields had already firmed up by 140 bps from the lows seen last August without a policy rate increase based on global and local factors explained earlier. At the extremely short end of the curve (up to 9 months) the yields are lower by 15 bps which reflects the unchanged policy stance.
What if the benchmark yield breaches the 8% mark? Will this lead to fresh inflows from investors or will it lead to panic outflows?
I really do not see a problem if the benchmark yield breaches the 8% mark. The 8% level is just around 5 bps higher from where we are currently trading and for an issuer or an investor 5 bps increase is not much of a change. From an investor perspective we have seen around $12-13 billion outflow from emerging market debt this year. About $4 billion of this outflow has been from India. Last year foreign investors felt that with strong Indian macros and an appreciating currency high yielding debt from India was very attractive with respect to the total dollar return it provided. This year conditions have changed a bit. The price of crude is higher and so is the CAD resulting in the currency giving up last year’s gains. In line with the higher risk perception currency hedging costs have also risen thus reducing potential dollar returns from investment in Indian debt. Additionally, higher dollar rates, an increased US fiscal deficit and resultant higher dollar issuances have provided some attractive alternatives for investors. Overall while conditions remain as currently expected I would not expect a substantial increase in FPI flows into Indian debt this year.
What are the implications of the rate hike on corporate bonds?
Locally, private companies have two ways of raising money – loans or bonds, but because of the PCA, there are 14 local banks that will not be able to extend credit. A couple of the larger private banks have also had their own issues with regard to NPAs and may not be very aggressive in disbursing loans at this point. Given this, we would expect reasonable dependence on the bond market for fund raising by corporates. In such a scenario we would expect credit spreads to increase. This is a trend that has been seen even globally.
There were talks about the latest RBI Circulars on FPI investments being a little unclear, how is it in your opinion?
There has been some confusion regarding this change in the policy and clarifications have been sought by investors who may need to alter their holdings according to the new rules. India has had a policy of discouraging frictional debt holdings by FPIs and of encouraging more stable bond investments. This has typically been implemented through restrictions related to residual maturity at the time of purchase by the FPIs. The proposed change to monitor FPI holdings via residual maturity on an ongoing basis and to put in place concentration limits on this basis creates a different set of challenges for the investors. Clarity has also been sought by custodians on certain aspects which could be difficult to monitor. We hope and expect that RBI will look at the representations and provide clarity on the issues soon.
How do you interpret the recent inflation projections and growth forecast for the second half?
Our economists are of the view that the RBI will subsequently alter their inflation projections for the second half, from 4.7% to 5.1-5.2%. The reason is that RBI has not yet quantified the impact of revision in MSPs in their projections. They also believe that the RBI will have to cut their growth projections from 7.4%. The reason for this claim is that RBI is underestimating the impact on growth of financial tightening and lower credit availability due to banks being classified under PCA. Our growth projection is currently at 7.3% with first half GDP holding up well but growth dipping in the second half of the financial year.