RBI to prolong pause, probability of hike small, says ICICI Securities Primary Dealership CEO

The recent rebound in inflationary pressures has sparked apprehension of whether more rate hikes are in the offing, but if one excludes the volatile movements in vegetable prices, the current levels of the consumer price index may not call for more tightening, Shailendra Jhingan, CEO of ICICI Securities Primary Dealership told Bhaskar Dutta. Edited excerpts:

Food inflation has hardened considerably and there are concerns over inflation spillovers. What do you expect from the MPC's policy statement on Thursday?

We think that RBI will retain the monetary policy stance of withdrawal of accommodation. The MPC will likely highlight the risks of elevated food inflation. A lot of it is happening due to higher vegetable prices, particularly tomatoes. That bit could probably be given less salience. What will matter more is what's happening to the other categories of food prices such as cereals, spices, pulses etc where we are seeing upward pressure. Those risks could be highlighted. It's important to track the CPI ex-vegetables. As long as it is around the current 5.2%, I think the repo rate is at the correct level. The market will be looking at the CPI forecast for the April-June quarter. In the last MPR (Monetary Policy Report) it was around 4.5%. If it stays under 5%, we can expect the policy to be on hold for a long period of time.


Are rate markets shifting back towards the policy-tightening narrative? Of late, some segments of the overnight indexed swap (OIS) curve are showing expectations of rate hikes.

The one-year OIS has gone up to around 6.90% levels, where about a 35-40% probability of a rate hike within a year has been priced in. I think the market seems to be reacting to two things there. One, there has been upward pressure on the 10-year US Treasury yield. It has crossed 4% again. Two, there has been a recent rise in commodity prices, particularly crude oil, due to the extension of supply cuts by Saudi Arabia and Russia. That is worrying the market because crude oil prices have a significant impact on inflation and monetary policy.

We would ignore the rise in US Treasury yields, but if there is a generalised rise in commodity prices due to higher stimulus in China, that could be a worry for the market and it could prompt the RBI to hike rates. But our base case scenario continues to be of a prolonged pause with a 15-20% probability of a hike in the repo rate over the next year.

The sovereign bond yield curve continues to be flat, partly due to the strong demand from long-term players. Do you feel that bond investors are failing to adequately price in inflation risks?

The term premium has collapsed due to a very strong investor appetite, particularly from long-term investors like insurance companies and provident funds. The fall in term premium seems to be more structural. It's not driven so much by monetary policy expectations. The 50-75 basis point term premium of the 10-year government bond yield over the repo rate is likely to stay. If RBI were to hike policy rates by 25 basis points then maybe the 10-year bond yield range will move to 7.25-7.50%. In the current set-up, it seems more like a 7.00-7.25% range.

If inflation risks persist, is there a chance of the RBI durably draining out surplus liquidity from the banking system?

That thought has crossed my mind - the core surplus liquidity is around ₹4 lakh crore. Even if we factor in currency outflows of close to ₹2.5-3 lakh crore in the second half of the financial year, given the fact that forex flows have been strong, our sense is that liquidity conditions will continue to remain neutral to surplus despite the currency leakage in the second half.

But it looks very unlikely that the RBI will durably drain out liquidity, given the fact that they have been over the last month continuously infusing liquidity through the forex route. If they're doing that, it seems unlikely that they would want to sell bonds and disrupt the bond market, given that the supply of G-secs is also fairly significant.

Which part of the government bond yield curve would you prefer at the current juncture?

Given the fact that we don't expect any rate cuts over the foreseeable future, we like the long-end - the 10-year and upward part, because we think that the investor demand there is significant. The second factor to consider is that the current quarter has the highest net supply of G-secs because of the lack of any redemptions. The net supply is ₹4.47 lakh crore in this quarter. For comparison, in the entire second half of the financial year, the net supply lined up is likely to be lower than the supply in the current quarter. That tells you that the demand-supply equation is going to turn favourable soon.