#4th IFIS – Indian Bond Markets – Travel through time by Mahalingam Gurumoorthy

The 4^th India Fixed Income Conference, hosted by CFA Society India – Chennai Chapter had a session on Indian Bond Markets with Mr. Mahalingam Gurumoorthy, who has an experience of about four decades in the financial markets working with regulators like RBI and SEBI. The discussion navigated through various aspects which could impact Indian and Global Bond Markets.

The session started with discussion on monetary policy cycle in the global and Indian Markets. Mr. Gurumoorthy mentioned that across the globe, there is huge upward traction in inflation. No geography whether developed or emerging market is in comfort zone as far as inflation is concerned and inflation is refusing to come down.  The US Fed has clearly indicated that it would do whatever it takes to kill inflation. One should also expect similar rate hike cycle in European Union and there is uncertainty over what happens in UK.

Specifically, in India, it is a million-dollar question of how far the RBI can increase interest rates. RBI’s inflation projection has been off the mark and it clearly appears that inflation is likely to be sticky than what is being estimated by the central bank. The prime driver for inflation is the oil prices and geo-political events. Both are not going off in a hurry.

The discussion then moved to topic – Is India insulated from world? Are we an oasis in an uncertain world? As per Mr. Gurumoorthy, a 6% growth in India is fantastic by global standards but low for Indian standards. Even though the India story is made from domestic demand, if US and Europe falter, a robust GDP growth will still be difficult. He stressed on the point that if the world is in trouble, India cannot be insulated. His concluding remarks on this topic was if India can achieve a 6% growth for next 2 years, we should be fortunate.

The next topic for discussion was the dilemmas faced by RBI about conducting government borrowing program. At present, Indian government borrows around 50lakh crore and this is a colossal task without disturbing bond markets. While there are various factors which the RBI considers, one of the key factors is the lock-step rate increase with US central bank. A typical rate differential between US and India which is conducive for FPIs to come is 400-500 bps and in an event of this differential narrowing, there would be no incentive for a foreign investor to enter Indian bond market. The rates at which the USD and EURO interest rates are expected to grow, external commercial borrowing cannot be undertaken. Therefore, foreign direct investment is the only hope provided there is further reduction in bureaucratic complexities.

While the bond portfolio may not see much traction, FPI equity inflow could be positive. Given all this, the overall traction of foreign flow will be subdued unless conditions become conducive.

Mr. Gurumoorthy then touched upon the topic of India joining the sovereign bond index. One of the key points of contention for India to join the sovereign bond index was the requirement that the entire bond space should not be constrained with any limits for foreign investors. This was not acceptable to RBI as the interest rate would be out of control. However, Mr. Gurumorthy strongly favours opening of limits and joining bond index. Even if India gets an index weight of 8-12%, there would be an inflow of USD 8-10 bn very easily into the country. Now, the big question – would this capital would be stable or runway on knee-jerk reaction? According to him, this is going to be a function, of how we would conduct our macros. It would also bring huge pressure on bureaucracy to conduct the economic policy in a very responsible manner.

The next key point being is it the right time now to join global bond index. The answer to this question depends on whether India should borrow in foreign currency or have FPI investment in Indian rupee debt. According, to him, if there is a FPI investment in Indian rupee debt and if there is a pull-out, the rupee gets affected and the interest rate gets affected. As against if India issues sovereign bond, there is no question of pulling out before contractual maturity date. Only change of hands would happen and this may only impact interest rate and not the exchange rate. The other important question, what if one borrows in dollar and rupee depreciates heavily?.

Since 1993-94, when Rupee was 31.37, average annual depreciation of rupee till now (which is 30 years) has been just 3.1%. So, does this imply that India need not hedge at all? In normal times, if depreciation is up to 4%, it would not cost much. However, if rupee depreciate in spikes, government should not bother much and adopt a passive approach. There could be volatility in short term but historical depreciation hasn’t been much.

The discussion moved to the topic on RBI’s policy to manage liquidity. According to him, if the Indian GDP needs to grow at 6%, liquidity is important. This is a huge challenge for RBI as overall liquidity has moved from Rs. 12 lakh crore surplus to negative liquidity/ Rs. 50,000 cr over the past 2 years. One part of liquidity called the durable liquidity was being funded by either through forex interventions or open market operations. In present conditions, RBI cannot do forex interventions and in fact selling dollars. Only source of liquidity is through open market operation. In the present situation, RBI will be focused more on durable liquidity and less on transient liquidity.

On the topic of state government borrowing, he confessed that there is no clear answer to why different states borrow at similar rate despite their varying fiscal situations. While market does not differentiate on different states borrowing, the rule book mentions that every state will have to take permission from central government for borrow. Thus, by giving permission to state government to borrow, there is an implicit backing from the central government. That’s the reason, state bonds are quasi government backed and hence all state bonds are similarly priced.

Lastly, the topic of discussion was on AT1 Corporate bonds. The discussion was specifically on the spreads for AT1 bonds being too less for the underlying risk especially after YES Bank situation. In the Yes Bank case, it was surprising that the RBI allowed entire Rs. 8500 cr AT1 bonds to be written off and equity investors were given preference over bond investors. The worst-case scenario should have been to convert it into equity. This incident creates a precedent where AT1 bonds have been written off completely causing losses to investors. Yet AT1 bonds trade at just 30-40 bps higher than 10-yr bond yield, which is surprising and it is not clear why this is the case.