‘Expect yields to harden further’
“THE GLOBAL MARKETS ARE EXPECTED TO SLIP INTO RECESSION, AND INDIA’S GROWTH AND DEMAND MAY TAPER”
After a spike in inflation and rate hikes by other central banks, the Reserve Bank of India’s (RBI’S) rate hike was fait accompli, says SANDEEP YADAV, head-fixed income, DSP Investment Managers. In conversation with Ashley Coutinho, he says the quantum and duration of rate hikes will be driven by the inflation trajectory. Edited excerpts:
What do you make of the recent announcement by the RBI to raise repo rate by 40 basis points and cash reserve ratio by 0.5 per cent?
After a spike in inflation and rate hikes by other central banks, the RBI’S rate hike was fait accompli. It is a defensive action, albeit a surprising one. We certainly expect yields to harden and the RBI to further hike rates. The quantum and duration of rate hikes will be driven by the inflation trajectory. My view is that inflation will continue to remain elevated, making it necessary for the RBI to hike rates significantly.
India’s benchmark 10-year bond yields have surged above 7 per cent in the past few weeks. How do you see the trajectory moving?
The 10-year benchmark rising above the 7 per cent levels is normal and should not be taken as a sign of instability. The underlying macroeconomic data has worsened considerably and bond yields are simply reacting to the data. I expect yields to harden further, necessitated by rising inflation, worsening current account deficit (CAD), and large fiscal borrowing.
In fact, India’s 10-year benchmark yield has been higher than the current levels, barring periods coinciding with the global financial crisis, demonetisation, and the Covid-19 pandemic.
What is your take on the spike in inflation? Is it more structural in nature and similar to what some developed economies are experiencing right now?
Some may argue that India’s inflation is driven by food and fuel prices. While that may be true, if inflation remains entrenched, it finds its way into core demand inflation. Even a supply-driven inflation can increase consumers’ inflationary expectations and percolate through to demand inflation. Even the RBI’S minutes from the May monetary policy committee has touched upon the fact that inflation is becoming broad-based and the inflationary expectations need to be controlled. It will be interesting to see the RBI’S next consumers’ inflation expectation survey to determine whether India is following the same trajectory. To summarise, a consistently high supply-driven inflation risks becoming structural inflation.
What is your view on the trajectory of interest rates globally? Will it accelerate the flight of foreign capital from India?
Globally, interest rates should continue to rise, although fears of recession will likely cap the rise in longer tenor yields. I do not expect a flight of foreign money from debt since the current debt holdings are already low, and residual debt holdings should be sticky.
In equity, we are witnessing outflows. More than the flight of capital, I am concerned about the inflow of foreign money.
India’s CAD is funded through capital account surplus. Since oil prices are expected to remain elevated, CAD is expected to be large. If rising global yields restrict capital account inflow, that is worrisome, especially for currency.
What are the kinds of debt products investors should look at right now?
For the time being, investors should prefer to remain in shorter duration products with up to one-year duration. While the yield curve is still steep and the longer maturities give a much higher carry, the markets are volatile. A higher carry may not be able to insulate the rise in yields. Although the curve may flatten, a long-term investor should remain invested in a shorter duration. We have witnessed only one rate hike by the RBI. It is prudent to wait and see how the inflation data unfolds and how the RBI reacts. The yields are not going to ease in the near future. It is better to be patient than invest in haste.