Rate volatility to continue on CAD, fiscal deficit worries

RBI in all likelihood will cut key interest rates by 25 basis points in the upcoming policy review, feels Dwijendra Srivastava, head of fixed income at Sundaram Asset Management. In an interview with Ashley Coutinho, he says volatility on the interest rate front is likely to continue as India tries to address both its current account and and fiscal deficits.

What is the quantum of rate cuts that you expect from RBI in policy review?

We expect RBI to cut interest rates by 25 basis points. It is not that the inflationary expectations are behind us, but the logic of cutting rates stems from two facts. First, GDP growth has been clocking below the trend growth in last three quarters despite a relatively hawkish stance from RBI. Second, the recent measures by the government look concrete and will address the fiscal profligacy to a certain extent.

Rural incomes are rising causing higher inflation due to demand for quality food items such as milk, fish and egg. The supply-side bottleneck can only be addressed in medium term by better policies from the government and better state-centre coordination. On other hand, urban savings are declining as inflation is eating into the savings and incomes are rising at a slower pace. This, coupled with a higher current account gap, gives limited maneuverability to the central bank.

Bond yields are hovering near 7.87% mark. How do you see the yields moving in the coming week?

We believe the benchmark 10-year bond yields will hover in a band of 7.75% to 7.95% in the coming week as the market participants have already discounted a 25 basis points repo rate cut and any rate action more than 25 basis points on repo rate can trigger further downside to the yields. On other hand, any hawkish statements or no action on the interest rate front can trigger an upmove on the yields.

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