Funds waiting in fray to keep yields in 6.45-6.55% range

For once, the Indian markets focused more inwardly than ever before as implementation of goods and services tax (GST) from July 1, impact of farm loan waivers on the broader economy and fiscal conditions and finally a well diverging Monetary Policy Committee (MPC) views on rates and inflation that was seen in the just released MPC minutes – hogged the limelight and economists’ attention.

The minutes of the June MPC showed divergent views with one member favouring a deep cut to another perceived inflation hawk advocating a ‘wait and watch’ view with a supporting argument that the recent softness in inflation reading was more likely a temporary phenomenon. In the final analysis, one did get the impression that there is marked divergence in the estimates of MPC on the gradient and trajectory of inflation and output gap, and these uncertainties may have led to an ‘erring on the side of caution’ and therefore a wait-and-watch approach. Food inflation remains a lesser worry now on account of a modest increase in MSP and prospects of a good monsoon. The farm loan waiver is also predicated more on the collapse of pricing power for the farmers as pulses prices have slumped. The focus was more on the output gap, where the consensus was that it could narrow down if GDP estimates materialised without any slippage.

The other two issues that dominated headlines and strategy-discussions will have a bearing on fiscal balances over the remainder of the financial year. First one, GST, gets implemented from July 1 and a lot of debate and clarifications/counter clarifications have preceded its implementation. This one-nation-one-tax regime (modelled on the Canadian tax structure) is structured to achieve efficient tax collection and facilitate easy inter-state movement of goods among other long-term benefits. The second one, the farm loan waiver, is a less unfamiliar exercise and barring the threshold and eligibility criteria and the implementing states, it remains the same as seen in previous episodes.

One of the fears for the markets is if farm loan waiver will result in fiscal breaches and lead to increased state borrowings. Experience tells us that state governments have met their gross fiscal deficits by capex cuts to meet the shortfall in revenue collection and therefore a similar approach could be expected. Further, the impact on GDP is seen at around 1% to 1.25% spread over a 3-5 year period depending on how soon the broader economy revives. Overall, both of above may result in muted and knee-jerk negative reactions over the course of the next few weeks for markets.

The rupee continues to trade in a narrow range with a strengthening bias. Moves towards 64.60 have generally attracted dollar sellers. With the Indian crude basket almost 10% lower, arising out of a general collapse in global crude prices, it should be seen as a harbinger for rate-doves.

Bonds have seen some weakness in the last few days post the release of MPC minutes. There appears to be lots of cash waiting to get in on weakness or spike in yields. Therefore, the near-term range should be within 6.45-6.55% in the benchmark 10-year bond.

NEGATIVES ABOUND

• One of the fears for the markets is if farm loan waiver will result in fiscal breaches and lead to increased state borrowings
   
• Further, the impact on GDP is seen at around 1% to 1.25% spread over a 3-5 year period depending on how soon the broader economy revives
   
• Overall, both of above may result in muted and knee-jerk negative reactions over the course of the next few weeks for markets

The writer is executive director, Lakshmi Vilas Bank