May see more tightening going ahead: Ananth Narayan, Standard Chartered Bank

In an interview with ET Now, Ananth Narayan, Regional Head, Fixed Income, Currencies & Commodities, South Asia, Standard Chartered Bank, gives his views on the credit policy. Excerpts:

ET Now: The majority of the market was expecting the governor to raise the repo rate by just a quarter percentage point, but he has actually gone ahead and raised it by half a percentage point. How would you read into that action?

Ananth Narayan: This action is clearly unequivocally hawkish, no questions asked. The market was divided between either the RBI raising by 50 and stopping there or raising by 25 basis points and then maybe taking some action on things like the savings account rate, a differential rate for borrowing, the 1% extra NDTL from the SLR and so on and so forth. What the RBI has done has done all of this together. Now you cannot get more hawkish and unequivocal than this. The reaction, therefore, has been immediate. We have seen yields jump up on the swap curve as well as in the government bonds by 7-8 basis point straightaway and the trend will likely continue given the clear nature of the message coming from the RBI.

ET Now: Should we then assume that 50 basis point hike that we have just seen happened is not going to be the end of the rate hike cycle and that we will continue to see rates hikes going forward, maybe another one in July even?

Ananth Narayan: I am sure we will see some more rate hikes going through. I do not think we have stopped here at all.

ET Now: Should we expect that the RBI will somewhere take a pause after this rate hike and maybe the next rate hike will only come in the next quarterly review and not in the mid-quarter review?

Ananth Narayan: I would be surprised if that happened, to be honest. I would expect the rate hike to come through in the next 45 days as well. The reason why we had a 50 basis point rate hike today as opposed to the normal calibrated 25 basis points was the fact that our inflation estimates were so off over the last few months really right from the beginning of the year. The policy statement also essentially turns what was a growth versus inflation debate to a pure inflation debate by simply stating that inflation eventually impacts growth. So by that token, what was seen as earlier a choice between growth and inflation, as far as the RBI is concerned, they are very clear that they want to tackle inflation and in terms of cost of funds to be honest, the fact that savings rates have also been increased by 50 basis points will have a significant bearing on the way the end customer who takes a loan sees the rate as because that is a significant portion of the bank’s liabilities and the direction of this particular move, a 50 basis points hike right now and the possibility and discussion around deregulation eventually does not really augur well for eventual rates to the customer. So to answer your question, rate hikes will continue in the next 45 days as well as oil prices are where they are and the uncertainties remain and possibly the end customer rates go up as well.

ET Now: Would you say it’s a fair assumption to make that aggressive rate hikes will lead to a significant increase in foreign investment into debt instruments in India, which in turn will allow the rupee to appreciate and that in turn will actually help temper imported inflation?

Ananth Narayan: Actually it could work in a perverse way to be honest. If the expectations are for inflation to persist in India and, therefore, growth to come down to 8% or maybe even below 8%, that actually works in a converse way where capital inflows balk at coming into the country. We have already seen this trend to be honest. If you see globally, the dollar has been weakening against almost every currency, especially the Asians, Malaysian ringgit, Korean won, Singapore dollar. The rupee really has not strengthened so much in this interim. Sure we have not gone down too much but we have not kept pace with the appreciation shown by the other currencies. So I suspect that if you continue with this rate hike scenario, which is a result of inflation and inflation being slightly out of control, you might actually see foreigners and investors overseas thinking twice about bringing in money right now until such time that inflation and growth come back into a more even keel. So the rupee part, yes, given the global weakness on the dollar, we should be okay but given where oil prices are and the issues that we have on the current account deficit eventually, I would not be surprised if rupee actually weakens against the dollar. I definitely expect it to weaken against other Asian currencies.

ET Now: Do you believe that the fact that oil prices are going up, the government continues to absorb this subsidy means that the net government borrowing number that we spoke of in the budget is easily going to be busted, we are going to see far more borrowings in that when we end the current financial year?

Ananth Narayan: Yeah, clearly there is a huge threat of that happening. The fact is even when the budget proposals came out in February, a lot of market participants were really questioning us to whether a target of 4.6% of fiscal deficit is reachable at all and in light of the sustained oil prices being where they are, clearly that’s being questioned a lot more. I do not expect the government to pass on the full oil price hike to the consumers, that would be completely out of question. So some amount of pressure has to be taken on the fiscal front. There is room on the fiscal front to be honest because the original target that the market was positioning itself for was actually higher than 4.6% fiscal deficit. So there is some room on that front and if the global scheme of things, India’s overall debt is not looking that bad compared to some of the other countries around the world, so it is going to be a mix of both. Once this round of elections is over, you will probably see some amount of price hikes going in the system and the rest would have to be absorbed by the fiscal. But two points to note really, the RBI is now effectively having a growth target, which is different from the budget target, 9% is what the finance minister indicated. RBI is closer to 8% now and RBI is also questioning as to whether the fiscal deficit target would be met. So clearly there is a bit of a dichotomy and I tend to go with the RBI’s assessment in this matter.

ET Now: What is the impact of the increased government borrowings that you see having on interest rates and a final thought from you on the outlook for interest rates?

Ananth Narayan: It starts off with the message from this policy, which is clearly inflation and inflation. A whole host of things, which have the background for this, the fact that our estimates have been off both from the RBI and from our sides consistently in the last few months. For the year going forward, we think average inflation could be as high as 8.4% month on month. The yearend March 2012 estimate, which RBI has given, does not give the full picture in that sense. Even 6% we must remember is actually higher than the RBI’s comfort zone, which it has defined earlier as 5%. All this is before the oil price hike is passed on. The risk here really is of complacency because we have seen 350 basis points of effective rate hike already, a lot of us were lulled into assuming that the rate hike cycle would end somewhere here. As long as we do not have a grip on inflation, it is really perilous to make that kind of an assumption here. To that extent, the risk really is that of complacency rather than of being too hawkish. On rates per se, one thing that the RBI has done very well over the last year or so is transmission of policy rates despite the fact that we are not close to the peak on policy, on repo rates, etc. The effective rate on CDs, etc., is pretty much close to all-time highs. So the transmission has happened well and with savings rate now being increased, an increasing talk of deregulation happening there, you might just see the transmission improving even better. It does not augur too well for end consumer rates, which are linked to base rates, which are linked to cost of funds and on the government bond side as well, given both the fisc pressures and the monetary view, you would see probably the 10-year bond move towards 8.5%. At some stage, the RBI will probably mull action on the SLR to ease the government borrowing programme, probably when the 10-year bonds go closer to 8.5% and maybe have to resort to a bit of buyback of bonds as well to ensure that the borrowing costs does not go too much. So all in all, a lot of caution, inflation is a problem and rates look like headed higher.