Bond bull market may pause but is far from over: Expert


After the Reserve Bank moved early 2015 to cut rates, it brought the benchmark repo rate down from a peak of 8 percent to 6.5 percent till before yesterday’s policy.

But the benchmark 10-year government-security yield remained stuck in 8-7.5 percent range through all of 2015 and half of 2016, moving lower to sub-7 percent only when the RBI promised in April to reduce the system’s liquidity deficit.

With the central bank slashing rates once more and the inflation outlook promising a few more cuts can follow in 2017, veteran observers of the bond market believe a 6 percent or sub-6 percent yield looks like a possibility next year.

Such a move will have a bearing on almost all vital economic functions. Cost of borrowing will reduce as loans are linked to the risk-free g-sec rate, banks will see profits on their treasury books and economic growth may perk up further.

In an interview with CNBC-TV18, Axis Bank Deputy MD V Srinivasan and Bank of America India MD and Treasurer Jayesh Mehta talked about the possible trajectory for bonds and the implications for the economy.

Below is the verbatim transcript of V Srinivasan and Jayesh Mehta’s interview to Latha Venkatesh and Reema Tendulkar on CNBC-TV18.

Latha: What did you make of the policy itself. Is this one first of a series of more cuts?

Srinivasan: I would think that the expectations of further cuts down the line have increased. With the initial anticipation pre-policy or after the last policy was that you will get 25 bps, this makes it 50 bps till the end of the cycle and that possibly is the terminal rate as far as this cycle is concerned.

While broadly that continues to be the case the case for further accommodation or further cuts possibly into the next year as more comfort on the inflation front opens up, clearly I would think this policy has kept the rate hope going. We could go to levels in terms of the 10-year much lower than where we are today.

Latha: Your thoughts, how many more, where is the 10-year in December or March?

Mehta: Last time when we talked sub-7 percent when the liquidity was infused, started about and as Srinivasan said earlier, there was expectation of one more cut till March. That continues, but I would say there is couple of changes which has happened.

The monetary policy statement is sticking to monetary policy style of it, rather than other developments and the way it pans out it does talk about upside risk but there is also downside risk on inflation and if one takes that call looking at the world today maybe next year we can see more cuts.

So, we might look into paradigm shift. Maybe initial stop for the 10-year at 6.50 percent or 6.55, people would rethink or people would book some profit but as things pan out in the next two months globally, that would determine the further course.

Reema: What would be the quantum of further rate cuts?

Mehta: That depends. Frankly speaking I would put it this way. Maybe December looks little difficult because you have lot of events, you have fed and US election coming through. So, maybe one more rate cut before March unless globally cues becomes very weak. But definitely next financial year we can look at further easing happening.

Reema: Once this FNCR-B overhang is out of the way what will be the transmission by banks, say in the next six months, how much do you think banks will be able to lower rates?

Srinivasan: If you look at what has happened in terms of policy rate since April and from the time Marginal Cost of Funds based Lending Rate (MCLR) has come through you have seen policy rates come off by 25 bps and most MCLR has come down almost by a similar extent. So, after this rate cut if you look at the next 3-4 months you should see MCLR rates come off by almost similar quantums as deposit rates come down further.

So, I would believe that overall the movement in deposit rates and lending rates would sort of follow what is happening broadly on the policy rate front and liquidity front and if you look at the liquidity stance which the governor yesterday claimed is unchanged than what it was before then you are clearly looking at reasonable amount of liquidity infusion in the second half which is both positive from a rate perspective in terms of rates going lower and also from a point of view of bonds. Bonds should be well supported.

Latha: Are banks therefore in a much better position, I am asking you a banking sector question with decent mark to market gains which we had not expected and even now the steel cycle and all doing well?

Srinivasan: If you look at the last couple of quarters you would see lower rates translating to better treasury profits for a lot of banks and that trend will continue and clearly it is good news for banks in terms of clearly you have an Statutory Liquidity Ratio (SLR) portfolio though there are limits in terms of how much you can sell from a held to maturity portfolio banks clearly have some room in terms of booking trading profits and that will clearly go to support their income in an otherwise very challenging environment.

Latha: What does it do to your non-performing loans (NPLs)? If rates go as low as you guys are saying another 50 bps cuts or thereabouts do many of your borrowers therefore come over this side of the wall who may have otherwise slipped and then you have mark to market gains? Do you think NPA position changes dramatically say, 12 months down the line?

Srinivasan: The NPA position is unlikely to change dramatically because of just rates coming down by 25-50 bps. It clearly gives more breathing room but when I use the word dramatically that may not happen. But things can change as more of these instruments become more amenable in these situations.

Clearly, if there is a pick up in the economy therefore if cash flows in earnings before interest, taxes, depreciation and amortisation (EBITDA) levels improve whether it is Scheme for Sustainable Structuring of Stressed Assets (S4A) or some of the other instruments, which RBI provided can come into play, that could help in resolving the NPA situation right now.

So, a combination of rates and some of the other policy instruments which have been put in place over a medium term perspective as you say over one year perspective there is a reasonable chance that we can see good improvement in the NPA situation.

Reema: The RBI has also said that you don’t need to classify the sustainable part of a restructured loan as bad. How much relief can it provide to an Axis Bank?

Srinivasan: All of you are aware that we have not concluded any S4A transaction till now as a banking system, the first few cases are still in the pipeline. As more of these happen this provides good relief. But as of now this is something which is useful but I don’t think so will change anything else in the books right now.

Latha: Let me give you a much longer time frame, say same time next year where might the 10 year be?

Mehta: I won’t be surprised if the global situation and global growth is somewhat similar to what it is today. I won’t be surprised to see it almost touching 6 or sub 6.

Latha: Sub 6 percent?

Mehta: Sub 6, because that is where one needs to take a call on what is happening globally because your inflation two factors are local which is services and food. Food is really taken care well by the government and therefore the rest of the inflation is what the global inflation is. That is where one needs to take a call what is happening globally.

Now, of course this is all subject to global developments. Tomorrow, if there is a turnaround which at this juncture doesn’t look like but if there is a turnaround globally then the things could really change by the way the world growth is happening. It doesn’t look like yields are or inflation is moving anywhere very soon.

Latha: Sub 6, would you concur, 12 months on?

Srinivasan: I will tell you my simple formula. If you look at policy rates and just put on 40-50 bps — if liquidity stance continues to be reasonably comfortable — that could be 10-year possibly around 6.15-6.20 levels. But if you believe that you have 75 bps to go, then you could reach somewhere where Jayesh is talking about.

Latha: Finally what is your sense about competition from the bond markets therefore. If we are talking about 5.95 or 6 in the wholesale market then debentures should be available for about 8-7.5 percent. Will you all be able to compete, is there are pressure on bank margins then?

Srinivasan: The spreads are unlikely to change between bank lending rates and what the bond markets offer and again I have always repeatedly said this in some of your shows that corporates will have to have a mix of both because one is a fixed rate markets and one is a floating rate markets. So, clearly bond markets will be used but the differential in terms of cost for corporates between bonds and loans I don’t think this is going to expand dramatically from this year.

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