Global markets: Near term outlook

US equities retain bullish consolidation mode in the near term

DJIA index held at lower end of 17500/17650-18350/18500 retaining near term bullish consolidation mode into higher end ahead of clarity from FED on shift to rate hike stance. The recovery from 17579 hit 18169 before firm weekly close above 18000 at 18080. This phase is confidence to US investors to stay local and not look elsewhere and comfort to non-US investors for valuation gains from underlying asset + currency gains. The index is up by 6.65% from intra-2015 low of 17037 (around 2% from 2014 close at 17823). It is not better compared against exchange risk adjusted returns for non-US investors. The US investor appetite shift from foreign to local and signs of FED rate hike not before Q4/2015 will extend bullish undertone to stretch all-time high beyond 18500. Now, all-time high at 18288 is at risk for extension into 18450-18550, while near term base is lifted up from 17500/17650 to 17750-17900. Let us set focus at 17750/17900-18450/18600 in bullish undertone.

US 10Y Treasury yield retain neutral undertone in sideways mode

The focus was set at inner-ring of 1.80/1.85-2.0/2.05%, and now losing count of back-and-forth moves here. US investors also get an opportunity to buy India at 7.80-7.85% (against US exit at 1.80-1.85%) and to exit India at 7.75% (against US entry at 2%) to play back-and-forth of India-US 10Y spread at 5.75-5.95%. There are no cues to review the set focus at 1.85-2.0% and economic data ahead will set up trigger for either 1.70-1.85% or 2.0-2.15%. For now, let us continue to stay focused at 1.80/1.85-2.0/2.05%, overshoot into outer corridors not expected to sustain.

DXY in sideways mode when FOMC divided (and not clear) on the way forward

Post (13th March) FOMC, DXY in sideways mode at set focus range of 96/96.50-100/100.50. Since then, DXY reversal from 100.39 found support at 96.10-96.35 for recovery into 99.99 for push back to 96.75 before neutral weekly close at 96.85. DXY YTD 2015 appreciation by over 7% against steady appreciation in equity and sideways mode in Treasuries is investor delight to retain demand for the USD (against major currencies) to retain DXY in bullish undertone, ahead of clarity in timing and quantum of rate hike. Given the expectation of 2-step 50 bps rate hike in Q4/2015, short term bias is for shift of trading focus into 100/100.50-104.50/105 from current sideways mode at  96/96.50-99.50/100. Till then, let us focus here keeping close watch on breakout signals.

Euro steady supported by neutral FED

EUR/USD boxed at set near term focus range of 1.0450/1.05-1.10/1.1050. The worry is from 7 times failure (from 18/3 to 6/4) at 1.10-1.1050, and the comfort is from lift of base from 1.0459 to 1.0519 to 1.0665 and now in sideways mode at 1.0750-1.09. Given the risk of run into parity (and beyond) in Q3/Q4 2015, strategic resistance zone at 1.09-1.10/1.1050 is rock-solid and seen as "no-long zone" for push back to 1.0450/1.05-1.06.

GBP/USD broke out of the 1.4650-1.5150 strategic focus zone with high at 1.5188. The comfort is from near term lift of base from 1.4650 to 1.4850-1.4875 against short term resistance zone at 1.53-1.55, which should hold for retest of 1.4550-1.4650.

USD/JPY held at either ends of set strategic focus range of 118/118.50-121.50/122 (118.60 to 122.02 to 118.30). While the short term outlook is reinstate of bullish undertone for retest of 122 enroute to 123.50-125, near term play seen restricted at 118-120/120.50 in sideways mode.

Brent in solid recovery mode, but seen stretched

It is solid 45% recovery in Brent Crude from 16th January 2015 low of 45.19 to 65.80 with firm weekly close at 65.28. MARKET PULSE strongly urged oil importers to hedge 6-12 month exposures at $45-47 to mitigate against the risk of relief rally to 63.50-65.00. During the journey, the base was lifted up from 45-47 to 50-52 to 60-62 for target 72, not ruling out extension into 80. All cues taken, prefer short term stability at 60-80, seen as win-win for all stakeholders. Having said this, hold at 72-80 will bring the focus back at 45-53. At $72-80, it would be prudent for suppliers to hedge 6-12M exposures to stay protected against risk of reversal into 45-52. For now, let's watch 60/62-71/73; while immediate bias is into higher end, will not be surprised to see reversal from there into 60-62.

Gold steady and sideways against mixed cues

Gold traded to the script between set strategic focus at 1120/1135-1220/1235; recovery from below 1135 failed above 1220 for push back into 1170-1185 intermediate support zone. The near term outlook is not shining for the Gold with bearish undertone into 1120-1135, while resistance zone is pushed lower at 1195-1210.

Over all, Global markets seen steady at set familiar ranges against neutral FED, finding it tough to take a firm stance on the timing of rate hike with limited bandwidth through 2015-2016.

Moses Harding

India financial markets: Near term outlook

Frenzy followed by panic: euphoric rally unwound at greater pace

Post the markets rally from August 2013 - May 2014, the last mile extension since mid December 2014 (into 1st week of March 2015) was at greater pace retaining the domestic hope and optimism, supported by RBI's shift to accommodative monetary policy stance and cues not in favour of FED shift into rate hike cycle! Most expected one-way upmove through 2015 and beyond, despite significant valuation re-rating of India assets not adequately backed by earning potential. MARKET PULSE urged to stay cautious ahead (Sensex over Mount 30K and NIFTY above 9K) from pent-up resistance to scale up valuation against higher base, when headwinds seen to emerge in realising the stated ambitions on set targets of macroeconomic parameters. The worst is seen to be behind, but the light for end of tunnel is clearly not at sight. Given the domestic headwinds in play, which will lead to disappointment (if not despair) and diluted tailwind support from external cues, H1/FY16 was seen to be period of bearish consolidation till emergence of better clarity for set up of directional bias ahead. Not to surprise, financial markets have been in frenzy (and panic) mode on a roller-coaster ride for significant valuation spike since mid December 2014 to first week of March 2015 followed by unwind of intra-2015 gain. Back to square one!

NIFTY reversal from set "hot-to-hold" zone of 9000-9150 held at "fair value zone" of 8200-8350 for punch below 2014 close of 8282 (at 8273). The worry is that Modi-euphoria (valuation re-rating by 37% from 6638 to 9119) since May 2014 is at risk of extended unwind!

BNF reversal from set "hot-to-hold" zone of 20650-21000 held at "fair-value zone" of 17500-17750. The reversal from 20947 (high on 7th January) and 20541 (4th March) held at 17798 (low of 22nd April), but was deep to take out 2014 close of 18736 and into striking distance of mid December 2014 low of 17502. Modi-euphoria rally from 12773 (by over 63%) is now cut down by 20%, and weak for more!

Rupee has also given up the intra-2015 rally from 63.62 to 61.29 with a new low punch at 63.64 before close at 63.56, below the 2014 close of 63.03. It is not major worry as the adjustment of 50-60 paisa is not significant to time-decay of 150-160 paisa since then. What is concern is the year-on-year fall by 9% from May 2014 high of 58.33 to April 2015 low of 63.64. There is no panic if seen against 2015 YTD rally in DXY by over 7% and Y-o-Y from May 2014 by over 19%.

EUR/INR is the worst loser with 2015 YTD loss of over 9% from 76.25 to 65.70. MARKET PULSE initiated coverage at sell zone 71.00-71.25 for unwind at 65.50-65.75, followed by squeeze in focus range at 66.75/67.00-69.00/69.25. It was also seen good for RBI to cut Euro reserves at/above spot 69.25 to mitigate risks against valuation loss and better yield (over 7.5% against sub 0.5%). This will also resist bullish undertone of USD/INR at 63.65-64.00.

10Y bond 8.40% 2024 has been relatively stable with back-and-forth move at 7.60-7.85% (105.25 to 103.60) as against mid December 2014 peak yield of 8.30-8.35% (102.42). RBI shift to supportive monetary policy stance through 2-step adjustment of Repo rate from 8.0 to 7.5% has helped to retain price stability. What is intriguing is the absence of 50 bps rate cut transmission for post-rate cut reversal of gains from 7.60-7.63% to 7.77-7.82%, as against 2014 close at 7.85%?

What next? Concerns emerge from slippage in macroeconomic fundamentals and nervous Rupee exchange rate

There are risk factors in play in shifting FY16 GDP growth momentum into 8.0-8.5%. Brent Crude recovery from $45 to over $65 and USD/INR bullish momentum at higher end of 61.65/62.00-63.65/64.00 against concerns on monsoon (and resultant supply squeeze) may retain CPI print at higher end of 4-6% comfort zone. Both combined, conflicts in growth-inflation dynamics will put RBI on back-foot on its accommodative monetary policy stance. The best is behind on the CAD in the short term from 50% spike in Brent Crude (from $45 to above $65 for near term consolidation at $62-72) and higher import of Gold. Export is also not seen in support to bridge the widening gap in the trade account. BoP may come under pressure on FIIs loss of appetite on India assets and slow down in ECB flows against risk from unhedged carry-trade exposures. There is better comfort on fiscal deficit for FY15 actual at 3.9-4.1% of GDP and higher confidence on beating the FY16 estimate of 3.9%. All combined, bullish euphoria is undone, thus diluting the investor (and stakeholder's) sentiment and the confidence on the short term through H1/FY16. The worry thereafter is the FED shift into rate hike cycle in H2/FY16 with minimum 50 bps rate hike. Taking all these cues in play into account, MARKET PULSE strategy was to unwind risk-on exposures in equity (for shift to risk-off Gilts and cash) and close USD/INR liability exposure.

Equity downside risks limited from long term investor appetite absorbing fair and cheap to acquire valuation

Is NIFTY at risk of giving up set support at 8265-8300? The concern is from shallow recovery from here, first at 8500 and next at 8350 for weak weekly close at 8305. The worry is also from losing sight of all-time high at 9120 to be replaced by 8850 now, against risk of test of 2015 low of 8065 ahead of mid December 2014 low of 7960. For now, let us set focus at 7950/8050-8450/8550 with attention on 8250, make-or-break point. The strategy is to buy in 2 lots at 8250-8265 and 8200-8215 with tight stop below 8200 or in sell-on-recovery mode at 8350-8500. Be prepared for either bearish consolidation at 7950/8000-8500/8550 or for bullish consolidation at 8200/8250-8750/8800 (within short term big picture focus at 7950-8850). Given the mixed cues and conflicting dynamics, stay neutral on hold or break of 8250!

BNF will be in bearish undertone against pressure on inflation, Rupee and Money market rates. Despite these negative sentiments in play, RBI support to Rupee and interest rates and heavy Brent at $70-72 (for recovery into $60-62) provide confidence to buy when the going becomes tough and nervous. All taken, do not see BNF risk below 17500 while 18500 is heavy in the short term. The strategy is to stay end to end at 17500/17650-18350/18500 with stop on break.

Attention on RBI to cut importer's fear and exporter's greed against FII mood-swing

USD/INR found firm support at 61.65-62.15 for shift of focus at door-step of 63.65-64.00. Can Rupee hold its ground at 63.65-64.00 is the uncertainty in play now? It would need lead-support from RBI to cut the lead-lag syndrome, importers rush-in and exporters hold-back. Exporters will be in greed for more, while importers (and carry-trade players) will be in fear to close exposures. Despite mixed (and nervous cues ahead), 12M $ is tough to sustain beyond 68.00 (where have seen multi-time failure for push back to 65-66.50) while it is good to cover near/short term $ liabilities at forward rate 62.85-63.35. Needless to say, risk to this expectation is on break of 64.00, shifting focus to 63.35/63.50-64.85/65.00, seen as low probability and RBI willing. For now, let us set focus at 62.50/62.85-63.65/64.00; hedge strategy to be around buying end May 2015 $ at 63.00-63.35 (spot at 62.60-62.95) and sell 12M $ at 68.10-68.35 (spot at 63.65-63.90). Having covered end April and May 2015 imports at 62.35-62.50, importers not to panic at 63.65-63.90 and to leave the street to RBI, exporters and carry-trade players (against the Euro).

EUR/INR trading focus was squeezed from 65.50/65.75-71.00/71.25 to 66.75/67.00-69.00/69.25 and now it's time to review it again. The make-or-break consolidation zone is seen at 68.50-69.25 with overshoot either way limited at 67.50-70.00. Euro exporters have lost margin from sharp reversal from 2014 close at 76.25 and intra-2015 high above 82.00. It is prudent for exporters to cover at 69.25-70.00 given the risk of EUR/USD parity in Q3/2015. There is huge interest at 1.09-1.1050 to offload Euro assets by investors and Central Banks. For now, let us watch sideways mode at 68/68.50-69.50/70; retaining breakout bias into 66.75-67.00.

India 10Y in extended bearish consolidation mode

India 10Y benchmark 8.40% 2024 is under pressure on possible delay in next round of monetary easing against risks from Brent Crude and Rupee. Rupee extended weakness beyond 63.10-63.35 (with new 2015 low at 63.64) and Brent Crude price-stretch beyond $65 has put 10Y bond under pressure for shift of focus from 7.75-7.77% to 7.78-7.80%, into higher end of set strategic focus at 7.60-7.85%. In the meantime, India-US 10Y Yield spread is in back-and-forth between 5.95% (7.80/1.85) and 5.75% (7.75/2.0) and now steady at 5.85-5.90%. For now, need to track 10Y at 7.75/7.77-7.80/7.82% (within near term big picture at 7.70-7.85%); higher India-US spread at 5.95-6.0% (7.80-7.85 versus 1.80-1.85) will limit downside risks not beyond 7.82-7.85%, but recovery beyond 7.72-7.75% is deferred for now till normalcy (and price stability) is restored in Rupee exchange rate.

Good luck and be cautious against sudden (and volatile) mood swings against low appetite either way!

Moses Harding

Global Markets this week (for 20-24 April 2015) : Extended risk-neutral phase!

Mixed cues between global growth (and geo-political) concerns and resultant comfort from passive FED on rate hike

Global macroeconomic fundamentals continue to stay fragile and weak. The short term outlook on Euro zone, Japan and China builds despair than hope. The only comfort is from higher probability of recovery in the medium term given the abundant liquidity support at zero (or negative) interest rates. The current combination of low growth - low inflation adds to price pressure on risk-on assets as investor appetite shift to risk-neutral and risk-off assets, thus retaining bullish undertone on sovereign bonds and Gold. The added worry is now from political tensions in the Middle East, driving the  Brent Crude prices up from higher risk premium. All these cues have diluted the risk of early rate hike from the FED, shifting the expectation to latter part of June to October 2015 by not more than 50 bps by end 2015.

Combining all these, the outlook for previous week was for consolidation phase in sideways trading mode within set ranges. DJIA index focus was set at 17750-18200 (saw intra-week recovery to 18169 for push back to 17748 before close at 17826). US 10Y bond traded in back-and-forth mode at 1.85-1.95%. Brent Crude was sharply up from above 54.50 to set target at 63.50-65.00 to hit 64.95 before close at 63.45. Gold in back-and-forth mode at set 1185-1210 focus with 1207 to 1184 to 1209 before close at 1204.15. DXY was volatile with failure at 100 for sharp push-back to lower end of set 96.50-100 focus (99.99 to 97.0 before close at 97.45). In the absence of clarity in near/short term directional bias, the strategy was to stay fleet footed in back and forth mode within the set ranges which has worked well. What next this week?

DJIA index has strong near term base at 17575-17625 and firm resistance at 18200-18300. The lift of base in 2015 from 17000-17050 is seen safe at 17500-17550 for building bullish momentum over all-time high at 18288 (seen on 2/3/2015). The near term positive cues are from availability of abundant liquidity at near zero rates and dilution in risk of FED start of rate hike cycle in June 2015. Till then, it is good to stay in buy-dips mode at 17550-17625 (with stop below 17500) for 18200-18300, which should hold. For the week, set focus at 17550/17625-18150/18225; overshoot, if any limited at 17500-18300.

US 10Y Treasury yield is now attractive at 1.90-1.95%, while set firm resistance at 1.80-1.85% (which has provided push back to 1.95-2.0% so far) is now at risk. The delay in shift to rate hike cycle, and in baby steps mode before extended pause into 2016 are positive cues in play to retain the elevated spread advantage in the yield curve. The strategy is to buy in 2 lots at 1.91-1.93% and 1.98-2.0% for 1.80-1.82 and 1.73-1.75%. For the week, set focus at 1.80-1.95% and overshoot not beyond 1.75-2.0%.

DXY traded to the script with failure at 100 and supported at 96.50, overshoot either side was momentary; moves so far has been in back and forth mode, from 100.39 to 96.26 to 99.99 to 97.00. There are no major cues to review this outlook for near term consolidation at 96.50-100 against short term support at 95-96.50 which should hold for eventual test/break of 100.39, with no clues to set upside target. For the week, set focus at 96/96.50-99.50/100 in sideways mode.

EUR/USD in back-and-forth mode since previous FOMC at 1.0450/1.05-1.10/1.1050 with 1.0456 to 1.1051 to 1.0519 to 1.0848 for close around 1.08. With short term outlook for parity and below, there is good amount of Euro supplies at 1.0850-1.1050 from Central Banks and exporters into Euro zone. None would like to hold assets in Euro currency despite sharp fall since August 2014, when there is no sight of strategic base (or firm floor support) as yet. Having said this, Central Bank's intervention fear support at 1.05 handle has delayed the inevitable move to parity by now, while sellers in huge at/below upper handle 1.10. For now, see resistance (above 1.0850) at 1.0935-1.0950 ahead of 1.10-1.1050 and support at 1.0685-1.0720 ahead of 1.0590-1.0615. For the week, set focus at 1.0590/1.0685-1.0935/1.1050, and under pressure for 1.0450/1.05-1.0525.

GBP/USD bit more volatile than Euro within the post FOMC range of 1.4550-1.5150 with moves from 1.5147 to 1.4563 to 1.5053 before close around 1.4950. Here again, against risk of more weakness in the short/medium term, GBP is heavy at 1.5050-1.5150 in anticipation of eventual break below 1.4500-1.4550. Till then, prefer back and forth at 1.4550/1.4650-1.5050/1.5150, overshoot either way not to stay for long.

USD/JPY has nicely traded back and forth of set strategic focus at 118/118.50-120.50/121 (118.30 to 120.84 to 118.54). Post failure at pre FOMC high at 122.02, focus range was squeezed at 118-121 and now may need to stretch it at 116-121, watching firm support at 116.50-116.85. Since the set up of strategic focus range in mid December 2014 at 115/116.50-123.50/125, have seen rally from 115.56 to 122.02 and there are no major cues for 115-116.50 to give way now, while heavy at 120.50-122. For the week, set focus at 116/116.50-119.50/120 in sideways mode.

Post the crash in Brent Crude from over 115, saw firm short/medium base at 45 for 45-65 consolidation; got to see recovery from 45.19 hit 64.95 before close at 63.50. The strategic base is now lifted at 52.50-57.50 and break of 65.00 will stretch the focus at 72 and 80, seen as all-win fair value zone and relief for oil importers only below 60.50-62.00 to get focus back at 56/57.50-63.50/65. For the week, prefer tight play at 60/61.50-63.50/65, overshoot either way tough to sustain.

Gold in consolidation mode at 1170/1185-1220/1235 post intra-2015 reversal from 1306 to 1143. There are no major cues to suggest overshoot either way in the near term against short term risk for weakness below 1135-1150.

India equity market in consolidation mode against mixed cues, adjusting for valuation

It has been orderly trades in NIFTY capturing investor sentiment and valuation. The rally from mid-December 2014 low of 7950 to intra-2015 high of 9119 was euphoric (and stretched on valuation) for push back to 8260 (into 8200-8300, seen as fair value zone). The recovery from 8269 was seen stretched at 8815-8850 for correction to 8550-8585. As per script, recovery from 8269 failed at 8844 for reversal into 8596 before close at 8606. Bank NIFTY volatility was high both ways, recovery from set fair value buy zone of 17500-17750 failed at 19000-19150 (high at 19038) before push back below 18350-18340. While the moves within set "fair value" and "hot to hold" zones provides comfort, the breakneck momentum either way is scare for stakeholders. What next?

Global cues continue to stay steady and impact neutral on India equity assets. Risk from FED is diluted now, and impact of 50 bps rate hike by FED before end 2015 is not seen as threat against RBI preparedness for 50 bps rate cut. The immediate worry is from domestic cues as euphoria premium is seen unwound, while retaining the positive sentiment from medium/long term hope on NaMo building stronger India. The concerns on twin deficits and inflation are behind despite firm Brent Crude and lower exports. The major uncertainty is on achievement of FY16 GDP growth target at 8.0-8.5%. All taken, short term outlook is neutral with no clarity on directional bias either way. It is possible that H1/2015 NIFTY "cap" is down from 9000-9150 to 8850-9000 (BNF from 20650-21000 to 19000-19350), while support at 8265-8300 and 17650-17750 is solid. Given the possibility of extension of consolidation phase beyond H1/2015 into H2/FY16, strategic investors may need to stay dynamic supporting bull protection at 7950/8200-8300 (and 16850/17500-17750) and taking money off the table at 8850-9000/9150 (19000-19350/19700).

The outlook for the week is mixed, but not beyond set near term focus in NIFTY at 8265/8300-8815/8850 and BNF at 17650/17750-19000/19100. Post the end to end recovery, unwind is now around midpoint intermediate zone of 8550-8565 (and 18350-18400). Two options now: either into bearish consolidation at 8265/8300-8550/8585 (BNF at 17650/17750-18350/18450 or into recovery mode at 8550/8585-8815/8850 (BNF at 18350/18450-19000/19100), with most trades expected to be at 8400-8750 (BNF at 18000-18750). Do not rule out CRR cut trigger into 8850 (and 19350), hence prudent to be in buy-dips mode at 8265-8400 (and 17650-18000).

India Gilts retain bullish momentum from RBI monetary support to growth and appetite shift from Equity to Debt/Fixed Income assets

India 10Y benchmark bond (8.40% 2024) has held at solid support at 7.80-7.82%  (103.80-103.90) for long now; rally from here hit 7.61-7.63% (105.25) on 4th April (post rate cut). Since then, it has been back and forth at 7.68/7.70-7.80/7.82 (103.75-104.50). What next?

There are no cues to suggest break down of 7.80-7.82% support, near term bias is in favour of recovery into 7.68-7.70% and 7.61-7.63%. India growth - inflation dynamics continue to favour shift to surplus system liquidity mode at lower interest rates. The trending in US 10Y yield into lower end of 1.70-1.95% is also of support for lower India Gilt yields, seen good to cut FY16 borrowing cost of the Government. All taken, most cues favour RBI delivery of CRR (and/or rate) cut soon. It is possible that RBI deliver 50 bps CRR cut ahead of June policy review. Till then, retain focus at 7.75/7.77-7.80/7.82 with bias into lower end awaiting RBI action for shift of focus into 7.68-7.70% enroute to 7.61-7.63%.

Strategic investment appetite is seen at 7.80-7.82% (against NIFTY squeeze at 8815-8850) and NIFTY at 8265-8300 (against 10Y bond sale at 7.60-7.65%). It is appetite neutral for FIIs against India-US spread stability at 5.85-5.95% in traction with 7.70-7.80% and 1.75-1.90%.

Rupee price momentum firm, but outlook nervous in the short term

USD/INR price momentum is stuck at 62.00/62.15-62.85/63.00 in traction with end April'15 range at 62.35-63.10 (same range focus for end March 2015). USD/INR not adjusting for interest differential time value and $ strength against major currencies retains Rupee dominant position (and strength) against global currencies despite RBI absorbing excess $ supplies. What next?

Rupee is not at risk from higher imports and lower exports, given the abundant $ supplies in capital account, and elevated FX premium support to exporters. There is nothing to worry from the CAD (having shifted the trend from above 4% to below 1%) or squeeze in real interest rate differential between India and US. The only risk is from the "forced" adjustment of Rupee to keep the over valuation under limit below 110%. All taken, stake holders need to cover the possibility of USD/INR base shift from 62.00-62.15 to 62.55-62.70 for shift of near term focus at 62.50/62.65-63.35/63.50. Retain hedge strategy in 3M at 63.50-64.50 and 12M at 66.85-67.85, overshoot either way is not expected to sustain. For the week, set USD/INR focus at 62.25/62.35-62.70/62.80, marginal upward shift from previous week focus at 62.00/62.15-62.55/62.70.

EUR/INR strategic resistance-cum-sell zone has moved down from 71.00-71.25 (high on 17/2/15) to 69.00-69.25 (high on 26/3/15) against firm near term support at 65.50-65.75, held twice on 12/3 and 14/4. There is significant squeeze in volatility range from 65.50-71.25 to 65.50-69.25, and now at 65.50-68.00 building risk for break-down below 65.50 into 63.00-63.50. For the week, retain focus at 65.50/65.75-67.75/68.00 with bias into lower end.

Have a great week ahead!

Moses Harding

Cover Story - Interview with Infrastructure Today Magazine

Extend ‘plug-and-play’ model beyond power sector

Link:- http://goo.gl/PlqblJ

Global markets outlook for 13-17 April 2015 : State of extended bullish consolidation phase

Global market dynamics steady, in the absence of fresh cues for extended consolidation phase

Market Pulse outlook for previous week was for bullish (risk-on) consolidation mode at inner-ring of near term ranges of 17000/17500-18000/18500 (DJIA Index), US 10Y Treasury yield at 1.80/1.85-2.0/2.05%, USD Index at 96/96.50-99/99.50, Brent Crude at 52.50/54-57.50/59 and Gold at 1135/1150-1220/1235. The "risk-on" investor sentiment kept the DJIA index in bullish tone with close above 18000, driving US 10Y yield up from 1.80-1.85% to 1.95-2.0%. USD index found solid support at 96.00-96.50 for swift recovery into 99-99.50 driving Euro down from 1.10-1.1050 into 1.05-1.06. Gold recovery from 1135-1145 support (and short squeeze zone) met 1220-1235 before sideways play at 1185-1210, while Brent Crude in end to end play at 54-59. Good so far, what next this week?

There are no major developments to review the bullish consolidation outlook against lack of clarity on FED stance on the timing and quantum of rate hike. While most stakeholders look for baby steps hike by not more than 50 bps through June to December 2015 followed by an extended pause through 2016, expectation on the timing of start of rate hike is mixed. Euro zone economic stability is underway with QE and NIRP support, while US economy recovery is seen to be round the corner. All taken, delay in shift to rate hike cycle (in baby steps) and extended monetary policy advantage to the US will retain investor appetite in favour of equity (against reduced allocation for bonds). The concern however will be on USD revert to bullish undertone ahead of time. For now, it is safe to assume that start of 25 bps rate hike deferred to Q4/2015 from Q3/2015.

The outlook this week is for risk-on bullish consolidation in DJIA index with shift of focus to 17750/17850-18200/18300. US 10Y Treasury yield is seen to be under pressure into higher end of 1.85-2.10%. USD index seen bullish for revisit to 100-100.50 with upward shift of support from 96-96.50 to 98-98.50. The risk of shift of reserves from Euro to USD and JPY has now come into play, adding strength to DXY. Gold is under pressure with shift of focus from higher to lower end of 1170/1185-1220/1235, but no major cues to trigger overshoot either way. Brent Crude retains its sideways momentum at 52.50/54-59/60.50 with breakout bias into 45-50 in the near term. All taken, it would be an extended consolidation phase, while looking for signals that would help FOMC to take firm stance on start of rate hike cycle, which is now seen to be between August to October 2015.

Domestic cues favour shift from bullish to neutral consolidation mode awaiting clarity on directional bias

India markets traded to the script. NIFTY extended gains over 8600-8635 to the doorstep of set "end of recovery" target (from 8265-8300) at 8785-8850. Bank NIFTY recovery beyond 18750 didn't have the steam for set target at 19350-19500 for back and forth play at 18350-18900. The damage is from RBI's status quo on 7th April, and the nervous (and mixed) tone on the guidance. In consequence, 10Y bond yield shifted focus from lower to higher end of 7.70-7.80%. USD/INR push back held at 62.00-62.15 (end April 2015 $ at 62.35, thus completing end to end of 62.35-63.15 focus range in quick time). The intra-week strategy was to unwind short dollar book at spot below 62.15, allowing $ recovery into 62.45-62.70. All taken, it is good start for FY16 in equity markets and Rupee exchange rate, providing double benefit for off shore investors, while rally in 10Y bond seen deferred for now against firm strategic support at/over 7.80%. What next?

Concerns on evolving conflict in growth-inflation dynamics and unwind of strategic investment book are major risks in play

While there are no major worries on medium to long term India optimism, short term outlook is not euphoric to chase elevated valuation from here. The domestic cues continue to stay supportive, but not meeting to expected outcome is worry; signs of set up of economic vibrancy may become visible in H2/FY16. This outlook may lead to delay in sovereign rating upgrade to H1/FY17, which is now distant away. The time-decay against limited upside in H1/FY16 will shift strategic investors appetite from equity to fixed income assets. It makes sense for strategic investors carrying investments since August 2013 to May 2014 to take monies off the table for 3-6 month temporary parking in Gilts and/or corporate bonds. An appreciation of 30 bps in 10Y Gilt in 6 month period is good for 13-14% annualised return, while equity assets stay in consolidation mode. Strategic investors will get reinstate opportunity at 7950-8250/8450 in NIFTY and  16350-17000/17700 in Bank NIFTY, while staying invested in 10Y Gilt at 7.78-7.83%. There is no need for FIIs to dilute India appetite, despite valuation pick-up in US, China and elsewhere. Stability in equity assets, work-in-progress for bullish Debt market and Rupee stability are positive signals ahead. The strategy for FIIs to lock in 10Y India-US spread at 5.90-6.0% works well, against India 10Y support at 7.80% and US 10Y resistance at 1.85%. All taken, in the absence of clarity on directional bias in the near term, it is prudent to stay in neutral mode, being "light" on risk-on equity assets for conservative play with higher allocation to Gilts and Corporate bonds. The short term investment theme is around staying heavy on fixed income assets and light on equity assets.

NIFTY relief rally from 8265-8300 is not expected to sustain beyond 8815-8850/8900 seen as "long-unwind" zone for equity assets or lighten the equity portfolio for shift to fixed income assets. Bank NIFTY is seen heavy at 19000-19150 ahead of major resistance at 19350-19500. At this stage, it is tough to set the extent of reversal. NIFTY has firm support at 8665-8700 and 8550-8585 with end of reversal zone at 8270-8470. Bank NIFTY has firm support at 18450-18600 and 18000-18100 with end of reversal zone at 17700-17850. For the week, will retain NIFTY focus at 8600/8685-8850/8935 and BNF at 18300/18450-19000/19150, in sideways mode. Having chased NIFTY from 9000-9120 to 8265-8300 to 8785-8850 and BNF from 20650-21000 to 17700-17750 to 18850-18900, it is prudent to take monies off the table on stretched bullish extension from here and stay aside (by shift to India 10Y at/above 7.80%) for deep correction. The comfort however is from upward shift of fair-value buy zone in NIFTY from 8200-8300 to 8400-8500 and Bank NIFTY from 17500-17750 to 18000-18250, seen as bull-protection zone.

10Y bond back at 7.80% post RBI policy, unwinding the impact of 4th March 2015 rate cut which saw recovery from 7.80 to 7.63% before push back to 7.75-7.80%. The comfort is from restricted volatility within set short term focus range of 7.60/7.63-7.77/7.80%. Now, need to be patient absorbing weakness at 7.80-7.83% enjoying the positive carry (against soft CBLO rate at sub 7.5%) and  awaiting shift of focus from 7.78-7.83% to 7.60-7.70% ahead of 7.35-7.60% (target by July - September 2015). The trigger for next rate cut will be on CPI stability at 5.0-5.5%, driving Repo rate to 7.0% ahead of start of FED rate hike squeezing the India-US 10Y spread to 5.0-5.5%. This spread is adequate to retain USD/INR exchange rate stability at 62-64, to the comfort of RBI.

USD/INR seen in comfort zone at 62.05/62.15-62.35/62.45 retaining the interest rate advantage with elevated FX premium at 7.90-7.50% across 3-12 months and at 5.85-6.0% in 10 year. The end to end play in end April 2015 $ set at 62.35-63.15 is done in quick time with spot Rupee recovery from 62.80 (low on 27/3) to 62.05 (high on 6/4). RBI support for the $ at 62.00-62.15 prevents extended $ weakness into lower end of set strategic support zone of 61.65-62.15 which is seen rock solid for pull back into 62.55-62.70 ahead of 62.95-63.20. The trigger may be from either lumpy $ demand or DXY rally beyond 100-100.50. The hedge strategy is to act at both ends of April 2015 at 62.10/62.35-62.85/63.10; 3M at 63.00/63.25-64.00/64.25; 6M at 64.25/64.50-65.25/65.50 and 12M at 66.50/66.75-67.50/67.75; strong appetite at both ends will retain spot stability at 62/62.15-62.85/63 till FED gets into rate hike mode, but time decay till then will cover Rupee weakness to 64 to protect the hedge play. We have already seen multiple times back and forth moves (within set strategic focus) without adjusting for time-decay, which is the serious concern for RBI keeping Rupee value at elevated levels against global currencies. For the week, let us watch sideways play at 62.00/62.15-62.55/62.70; with RBI protection at/above 62.00, break-out bias into 63.00 is the risk in play.

EUR/INR completes back and forth of 65.75/66-69/69.25 in quick time, since the previous FOMC meet. It is from combination of weak USD/INR at 62-63 against weak EUR/USD at 1.0450/1.05-1.10/1.1050. Euro did make multiple attempts at 1.10-1.1050, but didn't have the desired strength for last mile extension into 1.12-1.1250. With short/medium term focus at/below parity,  all stakeholders including Central Banks are keen to hedge Euro asset exposures and shift Euro assets to USD or JPY on recovery over 1.10. Now, EUR/USD will be under pressure into 1.0450-1.05 against steady Rupee at 62.20-62.45 to drive EUR/INR  into extended weakness below 65.75-66.00 for 65.00-65.25 which should trigger short squeeze entered at various levels from 69.00-69.25, 68.50-68.75 and 67.00-67.25 chasing EUR/USD push back from 1.10-1.1050 and USD/INR from 62.80-63.00 to 62.05-62.15. For the week, set focus at 65.00/65.25-66.50/66.75 in sideways mode, tracking EUR/USD at 1.0450/1.05-1.07/1.0750 and USD/INR at 62.20-62.70.

Moses Harding

Issues, confusion and lack of clarity around Base Rate

Is Base rate equivalent to LIBOR or reflective of effective lending rate?

Unfortunately, it is neither! RBI see Base Rate as mirror reflection of LIBOR capturing monetary policy impact. Since, LIBOR is short term money market rate across 1 day to 1 year, it is fair on the part of RBI to expect 50 bps rate cut impact on Base Rate derived from equivalent impact on sovereign debt, in this case T-bill YTM curve. It is also fair for borrowers to get this beneficial impact having opted for floating rate of interest.

On the other side, Banks (and most borrowers) see Base Rate as close to effective lending rate with significant portion of loan book priced at (or marginally above) Base Rate in credit products across Term Loan or Cash Credit or Working Capital Demand Loan. Since Banks are prohibited from lending sub Base Rate, most companies borrow outside Banking system for cost advantage (or arbitrage) using CC limits for raising funds through CP issuance at 1-2% sub Base Rate. While Banks are made to provide capital on limit sanctioned (even if significant portion remain unutilised over time), inefficiency from lower deposit rate (below sovereign yield) or holding huge excess SLR go unnoticed. RBI needs to do lots to bring in level playing field across stakeholders, instead of forcing in cosmetic adjustment in Base Rate. The theme should be around building clarity and transparency in pricing of funds (source/deposit or use/credit) not providing advantage to some at the cost of many!

RBI is correct in saying that changes in marginal cost of funds should be reflected in the base rate, and RBI is not seen in interference on the effective lending rate to the borrowers. It is not fair when both parties have settled for floating rate and marginal benefit is retained by Banks and not passed on to the borrowers. It is also necessary to reduce financial intermediation by non-bank entities through back-door CP route against unutilised CC limit. Had Banks been allowed to lend sub Base Rate, it would have given them the opportunity to lend at premium to the sovereign yield, thus shifting the excess SLR investment book to loan book. The issues (and restrictions) around Base Rate and inefficiencies in realistic pricing of credit need to be resolved for effective policy transmission on the ground.

It is immediate need to allow Banks to lend sub Base Rate. As a floor, Banks may be allowed to set Prime rate reflecting the Bank risk over sovereign risk, given the differentiation in risk profile. A risk premium of 25-50 bps over sovereign yield is adequate for this purpose. It is also desirable to build Prime rate curve across tenors (short, medium and long term) similar to LIBID curve (but stretched beyond 12 months), which can be used for pricing term deposit (and Time liability) products. Any adjustments in Prime rate should have parallel shift in Base rate.

What about transparency in pricing lending rates? Banks need to take into account statutory cost, credit risk premium, tenor/liquidity premium and margin, adjusted for relationship discount (for multi-hook non-credit products/services which generates CASA and fee income) while setting the lending rate. The transparency and clarity for the borrowers is highly inadequate. The bottom-line impact for Banks for credit exposure on the borrowers is from the NIM (adjusted for FTP) and fee contributing to RoA, which needs to be captured in pricing policy to be transparent and above board.

Immediate steps ahead to build efficiency and to ensure alignment with monetary policy transmission

1. Banks should set Prime rate across tenors for Time liabilities pricing, capturing the tenor premium/discount.  The premium over sovereign yield curve may be 25 bps for AAA rated banks, 50 bps for AA and 75 bps for others. This will give the depositors the benefit of risk differentiation between Banks.

2. Base rate should cover the statutory and operative cost over the Prime Rate, also ensuring to avoid cost subsidisation across products with different cost structure.

3. The effective lending rate (over Base rate) should cover credit risk premium, desired margin and relationship discount.

4. Banks should have the flexibility to lend between Prime rate and Base rate on marginal cost and yield basis. This will help to recover fixed costs from top line business build up.

All these will lead to capturing the monetary policy transmission impact on Sovereign yield curve, and to ensure parallel shift and alignment of the change in the Prime rate and the Base rate. There can be no issue on application of marginal cost on legacy credit portfolio, post contract for floating rate till maturity. Allowing banks to lend between Prime and Base rate will help to avoid slippage in credit portfolio (by cutting shift of CC limit to investment book of non-bank entities), and to provide level playing field for all stake holders across Banks, borrowers and non-bank fund managers.

Just thinking aloud as food for thought! The system should not need a stick for control and ensuring policy transmission; putting in place fool-proof frame work will help to build efficiency for better on-ground effectiveness!

Moses Harding

Emergence of conflicts in growth-inflation dynamics is worry!

RBI in mark-time mode looking for clarity on the if's and but's in play

It is not a major surprise to see this go as non-event. What is worrisome is the emerging conflicts between growth-inflation dynamics, thus shifting RBI from accommodative stance to balanced approach in the short term. RBI's FY16 growth outlook at 7.8% (against Budget estimate of 8.0-8.5%) and CPI expectation at higher end of 4-6% tolerance zone is not comfort to the stakeholders or to financial markets. While an accommodative monetary policy will build risk of CPI inflation overshoot beyond 6% (against monsoon and supply side worries), status-quo stance may push GDP growth momentum into 7.5%. In this scenario, it is safe to assume that next rate cut or CRR cut is not round the corner, and is distant away! It would need miracles to expect rate (and/or CRR) cut on or before June policy review.

Next rate cut subject to policy transmission is non-starter!

None realise that till end of 2014 (when Repo rate was 8%), Bank's Base Rate was heavily subsidised against 3-12 month deposit rates at 8.5-9.5%. Now that the marginal cost is down at 8.0-8.75% (on outgoing deposits), it has only resulted in relief (on the pain) but not yet into comfort zone to cut Base Rate. It is also obvious that elevated short term money market rates with steep inversion in the rate curve is not an accommodative stance when Banks ALM profile is skewed at lending long and funding short, thus squeezing the margin. It is essential that the rate curve has to turn flat, if not steep upward sloping for effective (and efficient) transmission.

No major take-away from the policy

Given the policy status-quo with build up of conflicts in growth-inflation dynamics with risk of extended pause mode, rest of policy guidance (and measures) have no great relevance.

Financial markets in bearish consolidation mode

There may not be great optimism till June-September; positive US economic data is major risk on India for extended pause in policy stance. 10Y Gilt is the worst hit for extended stay at 7.70-7.80%. NIFTY focus now is into lower end of 8270/8470-8700/8785 and Bank NIFTY under pressure at 17700-18700, while USD/INR in administered mode at 62-63/64.

It is not a great start into FY16!

Moses Harding

Indian financial markets this week: Consolidation against mixed expectations

Global cues mixed, hence impact neutral

All attention on US economic data to get clarity on the timing of start of rate hike cycle. While there is no discomfort on the US economic recovery and downtrend in unemployment data, confidence from growth-inflation dynamics is low on sooner than later rate hike delivery from the FED. The stakeholders guesstimate is sometime between June to October 2015. Barring this, most cues from other large economies continue to stay as tailwinds for India asset markets. The lack (or diluted momentum) of supporting tailwinds from the US is adequately covered by domestic optimism. While there is no risk on long term FDI appetite for India, concerns have emerged from sustainability of hot money FII flows, who may like to take money off the table given the not so significant upside in FY16, post the strong valuation pick-up since August 2013 - May 2014. The high base effect will cut the bullish euphoria from here. It is possible that FIIs may take a short holiday from India for return in H2/FY16.  All taken, impact from external sector on India markets will be neutral with limited pain or gain. The steady US unemployment data at 5.5% and low pick-up in weekly payrolls is relief into this week for India, but to stay in sideways mode between risk-on and risk-neutral. The rate-hike expectation swing between June to October 2015 will retain markets in consolidation mode without clarity on directional bias in the near term.

In the given mixed sentiment and lack of clarity on way forward, prefer stability in DJI index at 17000/17500-18000/18500, US 10Y Treasury yield at 1.80/1.85-2.0/2.05%, DXY at 96/96.50-99.00, Brent Crude at 52.50/54-57.50/59 and Gold at 1135/1150-1220/1235. There are no major cues to trigger break-out either-way. At this point, outlook is not in favour of June 2015 rate-hike, hence shift of sentiment from neutral to risk-on is the way to go this week. Beyond here, the next round of US economic data will set the tone for break-out of the said ranges either-way.

India optimism intact against improved macroeconomic fundamentals and RBI dovish monetary policy stance

Lot of policy initiatives and execution plans have come up in the 10 months of NaMo regime. While concerns remain on fiscal deficit and inflation, the worst is clearly behind and it could only improve from now on, with baby-steps in the short term (H1/FY16) and shifting gears to giant strides from FY17. The optimism now is from FY15 fiscal deficit at 3.9-4.1% and CPI stability around 5.5% till ease of pressure on food inflation before soft landing into 4-5% comfort zone. Given these evolving dynamics, it is fair to expect RBI action on 7th April review meet. It could be either 25 bps rate cut and/or 50 bps SLR cut and/or 50 bps CRR cut or combination of some of these to reaffirm RBI's stance for staying with growth supportive monetary policy, and to be seen in walking along with the Finance Ministry and the Government. The comfort from fiscal deficit, greater confidence on Rupee and the need to provide catalyst for lower lending rates would put pressure on RBI (not withstanding inflation worry) to deliver rate cut and/or effective liquidity action to ease short term money market rates. This outlook will drive bullish momentum into Equity, Gilts and Rupee markets.

Equity in recovery mode, but face major hurdles ahead of all-time high

After smooth bull run from the start of FY15, it was panic at the end; NIFTY was pushed down from all-time high of 9119 to 8269 by 9.32% and Bank NIFTY down by 15.24% from 20907 to 17719. The positive take-away is from set up of bullish momentum (from set fair-value zone in NIFTY at 8200-8300 and Bank NIFTY at 17500-17750) for smart recovery to 8600 and 18650 respectively to get the bulls back into the street. What next? The sentiment is positive ahead of monetary policy for extended NIFTY recovery beyond 8627 into 8785-8850 and Bank NIFTY beyond 18750 into 19350-19500. Will it sustain beyond here is the big question in play? The market is in "once bitten, twice shy" mode, post the 4th March rate-cut triggered collapse. For this week, pre policy support is firm for NIFTY at 8475-8525 and not beyond 8450-8465 (and Bank NIFTY firm support at 18300-18450, worst case not beyond 18050-18150). The strategy is to keep close watch at both ends, seen as extremes and would be high risk to chase overshoot beyond 8485/8550-8785/8850 and 18300/18450-19350/19500. The break-out bias beyond here is not clear now, and better to await clarity from FED and end FY15 India economic data. Till then, short term big-picture retained at 8200/8265-8785/8850 and 17600/17750-19350/19500. For strategic play for FY16, it is prudent to keep in mind the possibility of wild swings in NIFTY at 7950/8200-9000/9150 and Bank NIFTY at 16300/16650-20650/21000.

India Gilts firm, but in sideways mode on mixed cues

There is clarity on worst case in 10Y benchmark yield, which is at 7.75-7.80% but no clarity on to what extent short term bull run could extend within 7.50-7.65%. While CRR cut and/or rate cut is positive, minor risk is in the radar from SLR cut and/or alignment of HTM limit at/or below SLR. All combined, the short term consolidation range is seen at 7.50/7.60-7.70/7.80%. The strategic investment play for FY16 and beyond is to stay invested at 7.70-7.80% for 7.0-7.25%. The support for Gilts (and corporate bonds) will be firm on shift of investor appetite from equity to debt till clarity from the FED on timing and speed of rate-hike steps. At this stage, dilution in fear of June 2015 rate hike by FED (driving US 10Y bond yield into lower end of 1.80/1.85-2.0/2.05 range) will add fuel to bullish undertone for 7.55-7.70% play in India 10Y bond at yield spread of 5.75-5.85%.

Rupee stuck between devil and the deep sea

Rupee is at risk from contra stance between FED and RBI that would knock out the interest rate advantage. The devil is the medium term bullish set up of USD against major currencies (driving DXY above 100-100.50 on or before July - September 2015) and the deep sea is the squeeze in FX premium cutting $ supplies in the forward market. Balancing the impact will be RBI with huge $ appetite below 62, building ammunition power for Rupee protection at 63-64. As USD extends strength against global currencies, there will be pressure on RBI to adjust Rupee value to the comfort of exporters.

USD/INR has been in comfort zone at 61-63 with series of back-and-forth play, thus providing opportunities for importers to hedge short term liabilities at lower end and for exporters to cover medium/long term receivables at higher end. While most cues remained supportive to Rupee, RBI did extend protection to Rupee at 62.70-63.00 while absorbing excess $ supplies to squeeze the range play at 61.65/62.15-62.70/63.00. What next? Rupee is at risk of losing interest rate advantage (on ease in FX premium) and impact from USD bullish trend and reduction in FII flows, while the comfort is from sustainable FDI flows which may be lumpy but not consistent. So, RBI may need to turn to $ supply side till lumpy inflows can be absorbed into its books. This risk may not be relevant in the short term, but can not rule out rate adjustment in the medium term. The strategy so far was to sell 12M $ at 67.35-67.85 (for 66.50-66.65) with focus on end April 2015 $ in sideways mode at 62.20/62.35-63.00/63.15 (same range that was in focus for end Mar'15). It is now time to review this stance. All cues taken, USD/INR has solid long term support at 61.65-62.15 against risk of building bullish momentum beyond 62.55-62.70 into 62.95-63.20, not ruling out extension into 63.65-64.00. The strategy, therefore is to unwind short-dollar positions at spot 61.65-62.15. Importers need to cover 3M exposure at forward value of 62.85-63.35 and 12M at 66.00-66.50, while exporters stay aside for spike in 3M $ into 64.00-64.50 and 12M $ at 67.50-68.00 (post unwind of existing hedge entered at said levels). It is prudent to set NT focus at 61.95/62.20-62.55/62.70 with overshoot not beyond 61.65-63.00. For this week, spot USD/INR is seen in traction with end Apr'15 $ at 62.10/62.35-63.10/63.35, and good to unwind previous week short end April'15 $ entry at 63.10 on push-back into 62.10-62.35.

EUR/INR reversal from 69.25 held at 66.75-67.00, in alignment with EUR/USD push-back from 1.1050 to intermediate support zone of 1.07-1.0750, mid-point of NT focus zone of 1.0450/1.05-1.10/1.1050. The strategy to play end-to-end of 66/67-69/70 for big-picture has gone well. What next? There is near term relief for Euro with firm support at 1.07-1.0750 putting pressure at 1.10-1.1050 for 1.12-1.1250. The current EUR/INR value around 68.00 is at mid-point of 66/67-69/70 strategic focus zone with bias into 69-70, set as strategic short entry zone (for short term target below 66.75-67.00 into 65.75-66.00). For the week, retain focus at 67/67.50-69.50/70.00 for back-and-forth play.

Have a great week ahead!

Moses Harding

Simplified Operations for Statutory liquidity management: Time to review!

Cumbersome operational procedures leading to inefficiencies

Banks need to maintain statutory obligation out of the Net Demand and Time Liabilities (NDTL). To this effect, 25.5% of NDTL is taken away from the system in two ways: 21.5% SLR invested in interest bearing Government bonds (Central, State  and other approved securities) and 4% CRR in zero yield Current Account balance with RBI. This means that 25.5% Bank's sources of funds are impounded by the RBI. The rationale for this is attributed to dilute systemic risk (as fall back when in distress), to feed Government fiscal deficit, to cut financial intermediation leverage and ensure protection of public interest who invest in Bank's liability products. There is need to review the high level of impound against significant improvement in financial strength of Bank's balance sheet, fiscal prudence leading to lower dependency on Bank's participation (and emergence of non-bank investors) and adjusting the leverage to higher risk capital (upward revision of CAR from current 9% to over 12%) than over 25% of cash impound. There is also no merit in giving valuation shield on SLR investments through HTM protection over the mandatory requirement (current at 24% against 21.5% of SLR, seen as comfort to stay in risk-off Gilts than lending to risk-on credit). There is need to cut the level of cash impound (from 25.5% to below 20%), and reduction of HTM limit to below SLR limit!

There is also need to provide fungibility between SLR and CRR to simplify the operations involved in Bank's Treasury. The exercise of maintaining 4% of NDTL (on a fortnightly average basis with daily cap and floor) in Current Account with RBI is not an easy task against volatile net clearing differences. It is more difficult when large value lumpy money transfers are made through net banking without any information to the Bank. While the efficiencies built on Transaction Banking platform (to the delight of customers) can't be diluted, it is possible to make things easy for Banks through review of existing rules and procedures. Banks fund the deficit in Current Account through refinance of its excess SLR (at Repo or CBLO counter) or borrowing from Call Money market or swap of foreign currency sources in the cash/tom market. Needless to say, this process leads to huge transaction flows which are mostly repetitive on daily basis; Call Money lending/borrowing, Repo/CBLO borrowing and FX swaps are rolled over mostly with same counter parties, thus increasing the operating cost and risk!

Is fungibility between SLR and CRR a better option?

Step 1:

Banks should have the flexibility to maintain the Current Account with RBI at 0-4% of CRR requirement, meeting the shortfall from SLR portfolio. On the other side, any short fall in SLR can be met out of higher CRR (in the event of removal of HTM comfort to Banks). It means that Banks need to maintain the statutory requirement of 25.5% in aggregate of approved SLR securities and cash balance in the Current Accounts with RBI. There can be a minimum limit on each category to avoid excessive play, say minimum 2% in CRR (against the mandatory 4%) and minimum 18% in SLR (against the mandatory 21.5%).

Step 2:

RBI will charge interest on shortfall in CRR at Repo rate, and pay short fall in SLR at discount to Reverse Repo rate to compensate for the zero yield on excess CRR Current Account balance maintained to cover short fall in SLR.

Benefits:

It will drastically reduce the overnight transactions in Call money, CBLO, Repo and FX markets, thus reducing the load on technology platforms across CCIL and RTGS platforms. There will not be any settlement disputes between counterparts in the event of non execution of transactions due to human error and/or systems & technology failure. It will also bring in price-stability, cutting the volatility from last minute, lumpy demand or supply of funds.

Just thinking aloud into the ears of Raghuram Rajan (and commercial banks) to put mind to these critical operations to bring in cost efficiency and cut operational risks. To start with CRR fungibility within 2-4% will mean 2% CRR cut, when Banks hold huge excess SLR funded by NDTL.

If this is done, Government Bond yields will ease without cutting policy rates for effective (and efficient) transmission on lending rates.

Moses Harding

Will RBI surprise with rate cut when most cues in support? Bias neutral!

Ineffective rate transmission is worry:

RBI shifted into rate cut cycle in 2015 with two-step reduction in policy rates, pushing Repo rate down from 8.0% to 7.5%. RBI also diluted tight money policy stance through 50 bps cut in SLR from 22.0 to 21.5%, releasing additional monies into the system. It sounds good, and in ideal market conditions, lending rates (reflected from Bank's Base rate) should have reflected a parallel shift. But it is not the case with Banks reducing deposit rates and not lending rates! So, it is inefficient policy transmission and worse, it is ineffective to the discomfort of the Finance Minister and worry for borrowers.

The lack of policy transmission is due to elevated T-Bill yield at the shorter end of the curve; 91-364D sovereign yields are at 8.0-8.25% against Bank's CD rates of 8.25-8.50%. When the liability profile of Banks are skewed at shorter end, the yield inversion across 1-10 years (at 8.25 to 7.75%) has no impact on transmission. Assuming that lower cost of CASA deposits are covered for statutory and priority sector cost subsidisation (at higher operating costs to manage CASA portfolio), there is no room for Banks to cut Base Rate below 10-10.5% covering for operating & credit costs to maintain NIM at 2.5-3.5% and RoA at 1.5-2.0%. All taken, borrowing cost for borrowers (excluding blue chip and AAA clients) continue to stay high.

Need to remove restrictions at Repo counter and prepare for shift of operating policy rate from Repo to Reverse Repo rate

RBI continue to have firm grip on system liquidity through restrictions on availability of refinance at overnight Repo and part from term Repo counter. This means that full amount of excess SLR held by Banks is not available on tap at Repo rate. If this has been allowed, the rate curve will be inverted even at shorter end across 7-365 days in anticipation of rate cut and risk of call money rate sharp fall from 7.5 to 6.5% on marginal surplus liquidity. When Banks hold excess SLR to the tune of 5-7% of NDTL (against requirement of 21.5% and HTM protection for 24%), Repo coverage at 0-2% of NDTL gives limited room for rate pass-through to borrowing rates. Therefore, it is obvious that rate transmission will be more efficient through shift of system liquidity from deficit to surplus, without the need to cut policy rates from here.

RBI has two options now; either allow the operating policy rate shift from 7.5 to 6.5% through liquidity injection or deliver 50-100 bps rate cut to drive Repo (and operative policy) rate down from 7.5% to 6.5-7.0%. Given that SLR cut is cosmetic when banking system is in huge excess SLR mode, can RBI do more than 1% CRR cut?

Most cues in favour of lower operative policy rate

When FY16 GDP growth target set at 8.0-8.5%, momentum in core manufacturing sector at 1-2% is dismal. The growth agenda around infrastructure, agriculture, Make-in-India manufacturing and social inclusion will have lag impact on FY16, with significant impact on FY17-FY19. So, there is immediate need to cut cost of capital and finance. The long term risk on interest rates from twin-deficits are no more relevant. The comfort on Rupee is the other way now, not minding the rate-cut driven Rupee weakness into 63-64. The risk from FED shift into rate-hike cycle by June-December 2015 is diluted, given the huge external appetite on India. Most off-shore investors (and lenders) have significantly increased their India risk appetite, and in wait-and-watch mode for viable India opportunities. All taken, there is space for downward shift in operative policy rate from 7.5% to 7.0%.

Inflation outlook is mixed in the short term, which is holding RBI now!

RBI has set linkage between CPI and operative policy rate, with a spread of 1.75-2.0% between CPI and Repo rate. At this stage CPI around 5.5% and Repo at 7.5% fit into this benchmark. The concern however is the risk of CPI pressure into 5.5-6.0% on high food inflation. The flip side is the ease in fuel inflation with delivery of price cut in alignment with stability in Crude Oil price and Rupee exchange rate. Can delay in rate cut help soft landing of food (and essential items) inflation?

Obviously, No! If the FM could give assurance to the Governor that food inflation target will be managed through adequate supply (and ensure sustainability through addressing supply side concerns from monsoon impact), then RBI should not have hesitation in delivering 25-50 bps cut despite with short time lag, post the delivery of pre-Holi 25 bps rate-cut.

Choice between rate pause (with 50-100 bps CRR cut) and dovish guidance or 25 bps rate cut with caution on the way forward

It is not difficult for RBI to defend either a rate cut or short pause stance on 7th April policy review. More than the rate move, stakeholders will be more eager to get relaxation on the Repo counter that would push the 3-12 months sovereign yield curve closer to Repo rate if not below, against guidance of lower rates ahead. It will also be good for RBI to complete the rate cut cycle before FED begins rate hike cycle, earliest by June 2015. All taken, I would not be surprised to get 25-50 bps rate cut on 7th April, taking time (for better clarity on inflation trend) for release of restrictions on the refinance of excess SLR. If RBI view this as being over reaction ahead of better clarity on FED rate-hike timing (expected to be any time between June-October 2015), then guidance of short pause (on rates) and 50-100 bps CRR cut with higher entitlement at overnight Repo rate would be adequate (and desirable) for now.

Impact on markets: retain bullish consolidation in the short term

Gilts (and corporate bond) yields will ease, doubt is on the extent. 10Y benchmark 8.40% 2024 would prepare for consolidation at 7.55-7.70% on rate cut or expectation of cut in May 2015.

Equity market will shed bearish risks for shift to bullish (on rate cut) or neutral (expectation of cut sooner than later) undertone. NIFTY has now set firm short term base at 8270-8470 with pent-up momentum beyond 8550-8630 into 8785-8850, seen as short term cap. Bank NIFTY base at 17700-18100 is seen firm to retain bullish momentum beyond 18500-18750 into 19350-19500, seen as short term cap. It will be prudent for strategic investors (who have stayed invested from August 2013 to May 2014) to unwind part (or in full) while NIFTY at/above 8785-8850 (Bank NIFTY at/above 19350-19500) for push-back into 8000-8300 and 16500-17500 ahead of FED rate hike actions, as knee-jerk move to set up next round of strategic play.

The main concern will be on Rupee for minor shift of focus from 61-63 to 62-64, which is seen good for the system to balance exporters interest and inflation control. Given that worry on fuel inflation is behind, allowing marginal adjustment in Rupee exchange rate will be good to support exports and to realise the Make-in-India ambition; marginal weakness in Rupee (adjusting for recent USD strength) will be good for pipe-line FDI flows and exporters, without significant adverse impact on importers.

All taken, there are no cues to suggest set up of bearish undertone post-policy but need to tighten the belt for volatility within the set short term ranges of 8270/8470-8785/8850 (in NIFTY), 17700/18100-19350/19500 (in Bank NIFTY) and 62.00/62.50-63.50/64.00 (in USD/INR).

Good luck

Moses Harding