The rupee is in a very sweet spot

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Hitendra Dave, MD & Head of Global Banking and Markets, HSBC India

Hitendra Dave, the MD & head of Global Banking and Markets, HSBC India, believes the illiquidity in the primary bond markets could impact issuances which are already low. Dave told Shobhana Subramanian and Tushar Goenka in an interview that although there may be some pressure on the current account deficit given rising crude oil prices, there’s no need for an NRI bond issue just yet because the macroeconomic situation today is far better than it was in 2013. Moreover, the Reserve Bank of India (RBI) has adequate reserves and also another $10-15 billion as reserves in its futures bucket. Excerpts:

Is it not good that we have a depreciating rupee which is falling synchronously with peer currencies?

Per se, the currency is in a very sweet spot. We were at 68 (against the dollar) three years ago, too. We were in this situation in 2013 and in 2016 after the US elections, so I really don’t think there is any sense of panic anywhere.

The problem with controlled currency is that, under normal circumstances, you can take a simple rule of thumb, meaning when the current account deficit (CAD) widens, the currency weakens, irrespective of what is happening to the other currencies or the dollar index. However, situations are not so simple—the portfolio flows and foreign direct investments (FDI) flows can sometimes offset the current account or overwhelm it. Therefore, you can have fundamental reasons of weakness being overwhelmed by actual flows. For the past one year, what we have noticed is that the current account has widened and portfolio flows have also reversed quite significantly, largely from the fixed income market.

Do you think FPI outflows will taper off between now and December given they have been relatively modest in July?

The big equation is that higher oil prices mean bad for India. Some of it is true, other is exaggerated. I would like to highlight that, five years ago, the entire pain of oil going above $50 per barrel was taken by the weakest part of our economy, the fiscal. And now, the pain is taken by the strongest part of our economy, the consumer. Simply thinking, the fisc has no absorptive capacity, so they just bloated the fiscal deficit by issuing so much more security, which then makes the central bank nervous and the fixed income market nervous. So you have a currency problem which becomes a fixed income problem and a stability problem. This distinction has to be made that in the latter situation it is a consumer problem rather than a macro stability problem, at least in the interim. Personally, I think oil is headed downwards here, and then the incremental portfolio outflows will be much lower.

What is the single biggest problem in the Indian economy?

It is still the reluctance and unwillingness of the private sector to invest. It is a complex situation, and we do not know when it will get resolved. Very soon, people are going to ask where our equity is, show me a credible business plan and the like. Right now, the Indian economy is firing on two engines—the government and consumer expenditure only. The CAD is around 2.3% of the GDP now. When oil is cheaper, the economy is growing slowly, we go to levels as low as 1%. In overheated situation, we have gone to 4-4.5%. When 2% is considered normal, the current level should not be a sign of stress.

How are the borrowers faring in the bond market?

The only source of concern is that the fixed income market is illiquid, but not in terms of the amount of the liquidity in the banking system. Illiquid meaning the number of bid-offer spreads, the quantum at which one can enter and exit the market without significant impact cost. It started towards the end of 2017, when the yields had suddenly started moving up suddenly, local banks started worrying about the mark to market (MTM) losses that bonds would bring with them. The banks were already suffering from significant credit losses and the spike in the yield has given a sense of the banks having lost their risk appetite completely. In the financial market, banks are the dominant players, and if large banks choose not to participate in bond issuances, daily volumes fall, resultantly traders will have to align accordingly the amount of inventory they keep.

The frequent issuers are in a bit of a bother, mainly because fixed income markets are not open and the offshore fixed incomes markets are not very attractive. After the financial crisis, the amount of dollar liquidity was so huge that everybody had to be reassessed, which led to huge bond issuance from emerging markets including India. If you compare the issuances from January to June of this year to the previous years, even 2016 (barring the impact of demonetisation), I would be surprised if the current figures are above 50% of 2016’s. Banks today are finding that they are the only lenders in town. Because of that, their marginal cost of funds based lending rate (MCLRs) are going higher, the spreads they are able to command are better. No bank wants to deploy its surplus liquidity in treasury markets.

RBI’s open market operations (OMOs) have sucked out banking systems’ liquidity, at least in the last one year. In addition, the fixed income market has a zero risk appetite, and these two factors are self-fulfilling. Therefore, the more the people go to them for loans, the lesser people prefer bonds. All this, in total, has resulted in significantly lower bond issuances. Taking the point forward of the illiquidity I mentioned earlier, this type of situation most of us (bankers) have not seen for at least eight years. Even the largest issuer in the country is now finding it difficult to raise the decided amount in a single tranche.

The amounts have to be picked up through different rounds. All this has made the primary corporate bond market illiquid; secondary was always illiquid. It all narrows down to the problem that if banks remain primary lenders, when there is a problem, the banks are hit first.

Is this the right time to do another NRI bond issue, like we did in the past?

It is not needed at all. The genesis of the previous issue was something else. Essentially, you are telling the world that you have a surplus of $30-40 billion, which can be used as reserves. It is like an optical illusion, because in reality you have no actual dollars. You have borrowed from them and are promising to pay them back in three years—it is a plus and minus. But this plus part shows up in reserves and the negative one does not, similar to how the International Monetary Fund (IMF) counts its reserves. Apart from the reserves we see, RBI has another $10-15 billion as reserves in its futures bucket, which is not seen as reserves until they liquidate it. There are much better alternatives to this because the macro situations are not there yet, the level of currency weakness is not there yet, your reserves are far better so there is no use. According to many people, the rupee is still overvalued.



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