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Rupee pressured by deficit, bonds by rising rates

Rupee pressured by deficit, bonds by rising rates
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First Published: Wed, Mar 30 2011. 09 42 PM IST
Updated: Wed, Mar 30 2011. 09 42 PM IST
Mumbai: Higher oil prices because of the political instability in the Middle East and a tighter monetary policy from the Reserve Bank of India (RBI) could push down the rupee and local bond prices in the new fiscal beginning Friday, bankers said.
But they do not expect any dramatic action.
The moves will come after the rupee and yields on the benchmark 10-year government bond were range-bound in FY2011, despite a widening current account deficit and occasional jitters, thanks to the European debt crisis.
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The rupee is likely to end this fiscal at around Rs44.80 per dollar, not much of a change from its level of Rs44.91 per dollar at the start of FY2011.
The Indian currency had weakened to Rs47.70 per dollar in May 2010 as foreign investors pulled money out of the stock market as Greece inched close to a default. Later, the Indian currency jumped to Rs44.10 to a dollar in October before easing to Rs44.80.
Ananth Narayan, regional head, fixed income, currency and commodities South Asia, Standard Chartered PLC, said the foreign exchange market is almost in the balance. Exports have picked up to ease the pressure on current account deficit but foreign capital inflows have slowed as portfolio investors have moved money out of emerging markets.
“The balance of payments is precariously placed,” he said.
Narayan expects the rupee to weaken to Rs46 per dollar by June.
“Oil prices have to bite at some time and also FIIs (foreign institutional investors) may not return in the first part of the year because of concerns about high inflation in developing markets,” he said.
Bankers have been enthused by the steady growth in Indian exports.
Figures released earlier this month showed that exports grew by 27.5% in the first 10 months of 2010-11 over the same period of the previous fiscal.
Foreign investments in the stock market in 2010-11 have been similar to inflows in 2009-10.
In April-March 2009-10, foreign investors bought $23 billion of Indian stocks and so far in 2010-11 these investors have bought $23.73 billion of stocks.
Manish Wadhawan, head of interest rates, global markets at HSBC India, expects the rupee to move in the Rs43 to Rs.47 per dollar range.
“Exports have been doing well lately and even if oil is at $110, Indian consumption of oil in the last 10 years has grown only 5% to 6% (a year) which is very low considering the amount the Indian economy has grown, so rising oil prices have not impacted to that extent,” he said.
“But with double digit inflation and if oil goes to $150 per barrel, the sentiment could change,” he warned.
Like the currency market, the bond market saw flat yields. The yield on the 10-year 7.8% 2020 bond, a benchmark, is at 8%, little changed from 7.83% in March 2010.
Bankers, however, expect bond yields to move up in line with the likely interest rate hikes by RBI.
Mohan Shenoi, treasurer at Kotak Mahindra Bank Ltd expects the Indian central bank to hike its repo rate by 50 to 75 basis points in the next fiscal, from 6.75% currently. Repo is the rate at which RBI lends money to banks.
One basis point is one hundredth of a percentage point.
“We are expecting the repo rate to be the operative rate in 2011-12 with inflation at 7% to 7.5%, assuming the Indian oil basket is at $95 per barrel. Liquidity will continue to be in deficit,” he said.
Shenoi expects the 10-year bond yield to rise to about 8.3% to 8.4% by December.
“The difference between the 10-year bond and one-year securities is its lowest at 45 to 50 basis points. Both the short end and the long end of the yield curve only can go higher from here,” he said.
Liquidity in the banking system has dried up since June, when the government auctioned third generation mobile airwaves for a huge Rs67,000 crore.
In the ensuing liquidity squeeze, banks consistently borrowed more than a trillion rupees in November.
Currently, banks are borrowing anything between Rs70,000 crore to Rs90,000 crore through two separate daily repo auctions.
But bankers expect the deficit to come down to around Rs50,000 crore by end-June.
HSBC’s Wadhawan said liquidity will ease as the government starts spending more in the new fiscal, adding that he expects the 10-year bond yield to rise to 8.35% in the next six months.
Bankers said yields may not rise sharply because of improved liquidity and because RBI is likely to continue buying back bonds from the market to infuse money into the banking system.
RBI has been announcing bond buybacks since 2007-08. In 2010-11, the central bank infused Rs85,340 crore through this route.
“This has ensured liquidity and kept yields under check. Yields may go up, but it’s not a bleak situation. They may go up maximum to 8.35%,” Wadhawan said.
Graphic by Yogesh Kumar/Mint
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First Published: Wed, Mar 30 2011. 09 42 PM IST
More Topics: Rupee | Dollar | Currency | Bonds | RBI |