India’s headline reserves have increased by about $48 billion since January; adjusting for the rise in gold value, the reserve increase is about $43 billion.
With the government having announced additional borrowing this fiscal, the bond market has shown signs of concern over consistent supply of high-quality government securities. MS Gopikrishnan, independent market expert and former head of financial markets at Standard Chartered Bank, India, during an interview with FE’s Bhavik Nair, said more OMOs/Operation Twists would be needed in the coming months for the yields to sustain at current levels. Edited excerpts:
With RBI announcing Operation Twist, do you think the yields will stabilise despite the consistent supply of bonds in the market?
The net supply of G-secs based on revised borrowings is to the tune of Rs 9.65 lakh crore for FY 21 against Rs 4.7 lakh crore in FY20. In addition, there is an estimated net supply of SDLs to the tune of Rs 8 lakh crore vs Rs 4.9 lakh crore in FY20. This translates into an overall increase in supply of dated securities to the tune of Rs 8 lakh crore, which is approximately 4% of the GDP. That’s a large increase and there is an upside risk to this number. In my estimate, RBI may need to support the market through OMOs and Operation Twist to the extent of Rs 4-5 lakh crore during the year. You can say the announcement of OMO/ Operation Twist was eagerly anticipated by the market and this came as a relief to the G-sec market. Yields could move marginally lower on this announcement, but for the yields to sustain these levels, RBI has to announce more OMOs/Operation Twists in the coming months.
Did the credit guarantee facilities and other measures make any impact on the corporate bond market?
TLTRO-1 conducted in March had a tremendous response from banks and had the desired impact on AAA-rated corporate bonds. Since its announcement, AAA-rated corporate bond yields have softened by 200-250 bps and the credit spreads have compressed by over 100-150 bps. However, this still did not ensure liquidity for lower-rated corporates/NBFCs, which led to the announcement of TLTRO 2.0 in April with the aim to provide liquidity for smaller NBFCs/MFIs. While the intention was right, it didn’t find too many takers among banks as they were unwilling to take incremental credit risk. As the next logical step, the finance minister announced the partial credit guarantee scheme 2.0 where the Centre was willing to guarantee up to 20% of the credit risk on bonds issued by AA-rated and lower-rated or unrated NBFCs. There is not much information available on the offtake under this scheme; however, on the margin, this will have a positive impact.
What is your view on possible defaults in the corporate bond market?
We are in the midst of a crisis that has not been seen in over a century. Lives and livelihoods have been impacted like not seen in a very long time. This is bound to take a toll on everyone and everything sooner or later. Extended lockdown has only exacerbated the situation and unfortunately, the revival is going to take a long time, rendering many businesses unviable. This will spill over to the corporate bond market and impact some issuers. While the larger issuers may manage to survive, smaller ones will find it difficult to stay afloat for too long. So, I do expect defaults in the next few months/ quarters/years. This disaster can be averted or its impact can be minimised if the government moves quickly to revive demand in the economy.
When do you think FPIs will start putting their money back into Indian bonds?
FPIs have pulled out Rs 1.07 lakh crore from Indian debt since January; most of it after the Covid-19 outbreak in March. They seem to have slowed down their pace of sale recently despite the sovereign rating downgrade by Moody’s and outlook change by Fitch, which should give us some comfort. However, it’s too early to expect them to start putting back money into our bonds, especially with uncertainties on multiple fronts like fiscal, growth, financial stability, border tension etc.
RBI has been shoring up forex reserves that recently crossed the half-trillion dollar mark. Do you think the rupee will not appreciate beyond a certain point?
India’s headline reserves have increased by about $48 billion since January; adjusting for the rise in gold value, the reserve increase is about $43 billion. First of all, I should admit that the size of the increase and background in which it has happened has surprised me. If you look for the main contributors for this increase, it has come from strong concentrated FDI flows, fall in current account deficit and increase in unhedged exposure. But it is important to note that the rupee has depreciated by 6% during this same period, so the reserves accumulation by RBI has had an impact on the rupee value. With RBI intentions very clear, rupee appreciation will be limited and probably be capped between 74.00 and 75.00 levels. It can possibly move lower to 77.00 or so in the third quarter.
Raising funds overseas seems to be a big challenge in recent times due to the Libor cap. Do you think there could be some relaxation to the cap in current times?
The demand for investment grade Indian papers is quite good. On the high yield space, we witnessed a compression in spreads in recent weeks after the massive widening during March/April; the spreads are still wide. An increase in cap will help this category of issuers to tap the offshore market. I am sure RBI is looking at it and I expect some relaxation here soon.