Mumbai: Reduction in policy rate by the Reserve Bank of India is not leading to lower cost of funds because of structural rigidity, according to Federal Bank Executive Director Ashutosh Khajuria.
"By simply cutting rates, it is not helping the end user to get lower cost of capital. The problem that the RBI is facing is the non-transmission of signals and that problem is in rigidity of structures of some banks, banks are dependent on public deposits," Khajuria told Cogencis in an interview.
Banks' assets are 90% funded by public deposits. If borrowing accounts for only 3-4%, how can a bank be impacted by rate cuts, he asked.
"You have PF (provident fund), NSC (National Savings Certificate), Sukanya (Sukanya Samridhi Account Scheme) all close to 8%, how can a banker quote you less than 7%? He is finding it difficult to get deposits at 6.80%. That's the dilemma," he said.
Despite a cumulative 60 basis points of rate cuts between August and October, the yield on the 10-year benchmark 7.26%, 2029 bond has gone up because of concerns about fiscal slippage, he said.
"I think market is assuming the fiscal gap between 3.80-4.0% of GDP. It (fiscal deficit) may slip, but I think they will manage it below 3.5%," he said.
Khajuria expects a maximum rate cut of 25 basis points in December, but does not rule out a pause.
Following are edited excerpts of the interview:
How much more space do we have left in monetary policy?
On the monetary side, I don't see much space. You yourself have legislated for a median inflation target of 4% within a band of 2-6%. How much more can you cut is a question. You already have the policy repo rate at 5.15%, the lowest you can probably go is 4.50%. I am talking about too optimistic a number, even that would be a challenge.
With the market factoring in a rate cut and inflation being above 4%, do you think the market is overpricing a rate cut?
First, let policy rates settle down. Consecutive cuts are not required. They can take a pause, or a maximum 25-basis-point cut.
Inflation has gone up, but it has gone up only in one particular segment. Core inflation has gone down to 3.5%. So, the ability of the manufacturer to pass on the price is actually a challenge.
However, with core inflation being lower, the potential of it (inflation) coming up is that much lower and the potential of it easing is that much higher because vegetable and fruit prices need only three-four months to correct.
I am talking about the structural part. The legislated target is 4%. From there, there how much real rate of interest do you want? If inflation is 4%, do you need to have a treasury bill quoting at around 6%? Comparing inflation as base and then comparing it with repo rate is incorrect. Inflation rate is a year-on-year rate, it is rate of erosion in purchasing power this November compared to the previous November. So, you should see what the 364-day T-bill was in November 2018 and you should see how much was one compensated for erosion in purchasing power. If that is positive, how much positive real rate is reasonable?
Based on my inflation expectation for next year, I should have the T-bill rate today. If say the T-bill rate today is 5.60%, my inflation expectation is it should be around 4%, so where is the need for rate cut? If inflation target is 4% and T-bill is 5.70%, I am talking about 1.70% real rate of interest.
By simply cutting rates, it is not helping the end user get a lower cost of capital. The problem that the RBI is facing is the non-transmission of signals and that problem is in the rigidity of structures of some banks, banks are dependent on public deposits.
You have PF, NSC, Sukanya are all close to 8%, how can a banker quote you less than 7%? He is finding it difficult to get deposits at 6.80%. That's the dilemmIndia has a different kind of structure, different kind of rigidity and bank balance sheet.
Will we have to do open market operations for transmission?
It won't be politically correct because you are in a surplus liquidity environment--2 trln rupees of surplus cash. Unless lending happens, there is no justification for OMOs. Rather than injecting liquidity through OMOs, if they can do something like Troubled Asset Relief Programme for NBFCs (non-banking financial companies) where they buy good quality assets and based on those good quality assets, release some liquidity for NBFCs.
Where should the yield on the 10-year bond be at this point?
At 4.6% inflation, the rate (yield) is too high, 6.60% is too high. Even at 5.15% repo rate, you are having yield of 6.60-6.65% on the 7.26%, 2029 paper and 6.48% on the 6.45%, 2029 paper. So, despite rate cuts, yield has actually gone up. In July, you had the yield at around 6.25-6.30% level and from there, rate cuts of 60 basis points, you have actually seen yields rising. I think the market is assuming the fiscal gap at 3.80-4.0% of GDP. They may slip, but I think they will manage it below 3.5%.
How is the RBI going about its forex strategy? Are you getting a sense of what it is trying to do because reserves are going up, it seems to be active in the market?
The intention looks like to depreciate the rupee. If you look at the inflation-corrected parity, the gap between India's inflation and inflation in the US has bridged a lot. Now, you have a 1.5-1.75% range in the US and that in India was 3.0-3.5%, so the gap has come down. Unless the gap shoots up and crosses 5%, which it could temporarily, for competitiveness the depreciation should be in consonance with the inflation differential. The differential being around 2%, depreciation of 2% every year till this differential is closed would be good for the economy and conducive for exports. However, everything isn't dictated by exchange rate alone.
Even as we are moving closer to the monetary policy review, public sector units are not really confident about the yields on gilts coming down, they are selling at every level. Even at auctions, investor demand is not really there.
It is natural...when I have fear of the fiscal map going off, if I expect yields to not come down sharply, why would I buy? Ultimately, you have to mark to market. If there is an opportunity to make money you would buy, they are probably not convinced and inflation was not conducive.
Foreign portfolio investors have been looking at Indian debt assets, we saw a good amount of inflows earlier. What do you think is their likely strategy?
They are selling bonds of up to five years and buying longer-tenure bonds because they too don't see cuts happening. When you expect cuts, the flows for 0-5 years is the maximum and when you see that the spread is quite good and reasonable and your domestic currency is quite stable, you naturally invest in high-yielding assets. The rest of the world has close to zero and negative yields. They look at emerging economies and within that, whatever said and done, India seems to be a reasonably good economy to invest in. Flows are coming not only in equities, but also in debt. Maybe, rest of the system will follow them because that gives confidence that if someone from outside is so bullish on bonds, that may give a lead. But it is not being reflected in yields. While FPIs are buying, you have domestic players selling.
Indian banks are more worried about fiscal slippages. FPIs may have more confidence in the government meeting its fiscal target through disinvestment. When FPIs come, they do so in droves...when they sell, they would sell massively. That is something that always comes with FPI investments. Domestic banks don't buy that aggressively.
