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“I have been bearish on bonds but if one sees major forex outflows augmenting the RBI’s ability to buy through OMO, then we do not really see yields fly off the handle,” says Indranil Sengupta, Head of Research, CLSA India.

After the googly from the RBI Governor yesterday, what is it that you are working with in terms of an assumption? What happens next? How many more rate hikes can be expected and what are the inflation projections?
We obviously had rate hikes but although yesterday’s timing was a surprise, we are looking at another 100 bps of rate hikes which will take the terminal repo rate to 5.4% in FY24. As far as inflation goes, we are around 6% average for this year. It is not so much inflation as the fact that the rates are too low. That is why there are negative real rates and once the Fed starts to hike, all emerging market central banks including the RBI have to follow suit.

So 40 bps may not do the trick and another 100 bps is coming. What are the chances that Reserve Bank of India in its attempt to control inflation may actually damage the economic recovery which happened after Covid?
We are actually seeing 80 bps rate hikes over a month because there was a defacto 40 bps hike even on April 7. All over the world, central banks are being pushed into a situation where you have to sacrifice some amount of growth to bring inflation down and we are no exception. We think there is another 25 bps downside risk to our forecast of 7.1% FY23 inflation.

Lot of experts are saying that we are in for a repeat of 2011 and 2012 kind of a scenario, which is low growth for long and high inflation. Then we saw collateral damage to the economic growth. It led to an uptick in the NPA cycle and it broke down the so-called feel good factor. What are the chances that the cycle may repeat itself?
A lot depends on where the US goes because as of now, our base case is that the US growth slows down to 1.3% next year from around 3% this year. If the US were to slip into a recession, that impacts India’s growth by 150 bps. As of now, we are looking at a 5.5% growth for FY24 with the US recession that can go to 4.1%.

As far as the scenarios of the 10 years ago are concerned, number one at that time was that the RBI had waited and the market kept on saying that the RBI should be hiking. This time, the wait is much lower. RBI has already reacted. Secondly, we have sufficient forex reserves to control imported inflation, something that we did not have at that time.

Would you like to see the jugalbandi between the government as well as the RBI to turn towards the forex reserves? This argument has been made since 2020?
I think the RBI should be raising as much of forex reserves as possible. We are looking at a possible hike in the) NRD or the FCNRB deposit rate because it is just not that the Fed is hiking, they will be withdrawing liquidity of $47.5 billion right now and then $90 billion every month from September. So forex flows are going to be hard to get, which means that one has to strain every nerve to hold on to forex reserves and build on them.

From the market perspective historically, we have seen that when rates go up, banks do well and staples do well. This has turned out to be a domestic investors’ market with FIIs in a sell mode. How do you see that impacting flows?
There are three ways in which the Fed affects Indian markets; the first is of course the spill over of liquidity. When the Fed puts in QE, we get money. When they do QT, we do not get money, the money flows out of something and that has been happening.

The second is the expectations factor. The correlation coefficient between the Nifty and S&P is somewhere close to 0.96 over the last 17 years. Eventually, Indian expectations and expectations all over the world are largely set by what happens to US markets.

The third is that the relationship between Fed hike, growth and markets are not linear. If the Fed is seen to be sounding all clear, saying that there is recovery now and I am normalising monetary policy, you will see Fed hikes sit with growth, sit with rising markets. Maybe rates go up but then we are making much more in equity returns.

When the Fed fights inflation then it is a very different story because then that goes and damages growth and I think the concern is that if you go and look at the data for the last maybe 50 years, you find that no bout of high inflation in the US has been resolved without a recession. And like I was saying, if there is a US recession, that will impact India by 150 bps of GDP. So yes, we have to wait and see how the Fed goes and to what extent the Fed goes and what it does to US growth because as of now, the US is the only engine of growth in the world.

What you are saying then is that we are very much not an island in this globally connected world. I am just quoting the governor’s words from yesterday. If the Fed does move, we are bound to shake as it is?
Yes, when the US sneezes, the world catches a cold. We are relatively more immune a) because we are largely a domestic driven economy and b) the fact is that Mr Das has built up high forex reserves but yes, if the Fed hikes, no emerging market central bank can avoid following it. If the US growth slows down, it is going to slow down global growth and India’s growth as well.

In your assessment, how high could the 10-year paper go? Are we looking at 8.5-9% or would that be a stretch?
For sometime, I have been saying that for a year, the 10-year will settle somewhere around 7.5%. On the one hand, the RBI is hiking, on the other hand if you have forex outflows, then RBI’s room to buy government paper through OMO is also going to rise. The very fact that they did a CRR hike will also add to their ability to buy government bonds.

If they extend the HTM limit to say FY26, they may get more money going into bonds. So yes, I have been bearish on bonds but if one sees major forex outflows augmenting the RBI’s ability to buy through OMO, then we do not really see yields fly off the handle.


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