Global recovery has started losing momentum, impacted by resurgence of infections in several parts of the world, supply disruptions and the persistent inflationary pressures.
Two events – Yemen Conflict and Ukraine Conflict - have somewhat unsettled the outlook in 2022. With inflation persisting at high levels, several EMEs were first off the mark in normalising and even tightening monetary policy.
In AEs too, persistent price pressures have induced some of them to raise policy rates. Federal reserve (Fed) has dropped any reference to inflation as 'transitory', with the Fed instead acknowledging that price increases had exceeded its 2 percent target 'for some time.' Build-up to first Fed meeting has already seen sharp correction in equity prices and rise in treasury yields in the US.
Yields in India have steadily risen in narrow band. Surprisingly, the market participant as gauged from latest RBI professional forecaster survey underpriced the impact of rise in yield in response to Fed announcement. The yield is expected to continue northwards in Q4.
We believe G-sec rates could move in the range of 6.4-6.8 percent (pre pandemic level). We expect that even though signaling repo rate may be capped at 4 percent by the RBI, through much of FY23, a spread of 275 points over repo rate may be risk spread given the demand supply inequality. It is expected that crude price might stay high in near future at current levels.
However, amidst all this, there is a silver lining. The markets may have factored in that the current Omicron will result in a endemic stage in the COVID cycle and thus a faster normalization of economic activities. Additionally, in any rate hike cycle, the financial markets actually does better as any material risk is factored in the prices. Interestingly, for India, with TREP and call rate currently at much higher than reverse repo rate, we believe the stage is set for a reverse repo normalization.
In the Indian context, during the growth boom for the 3 year-period ended 2008, when the signaling rate /repo rate jumped by 275 basis points, the NSE Index had jumped by 79.1. Interestingly, for the 2 year-period ended 2011 , when rates jumped by 375 basis points, NSE Index did jump by a staggering 54 percent. Clearly, better risk pricing always results in better price discovery in markets.
We believe that the redemption pressures of the Government is going to be significantly large and will peak in FY27 at Rs 6.25 lakh crores. The redemption of G-secs are particularly large beginning FY23. What is more significant is that average oil bond redemption at Rs 35,000 crores will be an added headache from FY24 onwards.
Considering all this, the RBI and the Government in conjunction will have to do large switches in next couple of years to manage the redemption as a part of signalling.
(The writer is Group Chief Economic Adviser, State Bank of India)
