India’s Monetary Policy Committee may continue hiking the policy repo rate even after the emergency accommodation provided during the Covid crisis is unwound. This, according to B Prasanna, head of global markets at ICICI Bank Ltd., could mean that the repo rate moves up to 6% by February next year.
The MPC is widely expected to raise rates on Wednesday, with expectations split over the quantum of the hike. According to the median forecast of 37 economists surveyed by Bloomberg, the benchmark rate will be raised by 40 basis points to 4.8%. The committee raised the repo rate to 4% in an emergency meet in May.
“The next 75-100 basis points is almost a no-brainer, because this is just unwinding of the ultra easy policy put in place during the Covid crisis,” said Prasanna. “Once that is done, the RBI will have to take a call on how far they go.”
Some parts of the markets, though, are building in steeper monetary tightening.
The surprise repo rate and CRR hike announced in May has led to one of the sharpest reactions seen across markets, barring the actions taken during the global financial crisis, said Prasanna.
Since May, the swap curve has gone up by almost 130 basis points, treasury bill yields have climbed 100-120 basis points, even though the reaction on the benchmark 10-year has been more muted.
The swap markets, in particular, is pricing in a repo rate of 7% one year from now, said Prasanna. The same market is signaling that the repo rate could be close to 7.75-8% even four years from now, he explained.
Is the market running ahead of itself?
According to Prasanna, part of this is the “uncertainty premium”. This uncertainty is coming in from two factors. “First, where does crude go? Does it go to $130 per barrel or even higher to $150 per barrel? Second, where does the Fed stop? Could it go to 3.5-3.75% on its benchmark rate which is currently not priced in?” Maybe there is a reason for what the market is expecting, Prasanna said.
Against the expectation of the repo rate heading to 6-6.5%, record high supply of bonds and tighter global financial conditions, will yields on the benchmark bond head even higher? The 10-year yield hit a three-year high and moved above 7.50% ahead of the policy review.
Prasanna said the benchmark yield could move towards 8%, although not immediately.
“When it comes to the bond market, you are not only looking at the rate hike expectations but also supply and demand,” said Prasanna. On the supply side, the fiscal deficit is likely to exceed the budgeted deficit by close to Rs 1.5 lakh crore even though, in terms of percentage of GDP, the slippage will be lesser due to high nominal GDP growth.
While receipts may be stronger than budgeted, expenditures are also rising. As such, “the government may still have to bridge the gap to the tune of about Rs 1.5 lakh crore,” he said.
From a demand perspective, after accounting for the normal demand that comes from banks, insurance companies and pension funds, there could be a gap of Rs 3.5-4 lakh crore between supply and demand, Prasanna estimated. The RBI, which in the past few years, has stepped in with open market operations to buy government bonds is unlikely to be able to do so this time as it is tightening monetary policy. Foreign buyers are also missing.
Higher oil prices, alongside complicating India’s inflation outlook, are also worsening the trade deficit, which widened to $23 billion in May. For the year, the current account deficit is being estimated at close to 3% of GDP. With capital flows remaining weak, this level of deficit is also likely to pressure India’s balance of payments.
The RBI’s interventions, however, may prevent a sharp depreciation in the rupee.
“Left on its own, the rupee would have already crossed 79/$ but the RBI has done a good job in intervening. I think, a year down the line, we could probably see 80 against the dollar but that’s not saying much since forward rates are already predicting 80-80.50 levels,” Prasanna said.
Watch the full interview below: