Market reaction to monsoon will tweak rate trajectory: Saugata Bhattacharya, Axis Bank

In a chat with ET Now, Saugata Bhattacharya, Economist, Axis Bank, says we will get some traction on growth during the second half. Edited excerpts

ET Now: What is happening with the bond markets?

Saugata Bhattacharya: We all are trying to track that and it is great fun. I mean where is it likely to head after all this? So I think the immediate trigger has been liquidity and the OMO auction that is coming in. The promise of neutral liquidity I think has played a part. Markets are forever expecting another rate cut. With the good rains with oil having stabilised, I think there is a prospect of rate cuts coming in if not in October, at least in December. The supply-demand balance also looks to be fairly okay.

ET Now: But if the repo rate is at 6.5 and already bond market investors are talking about how the yield could go below 7, you are really looking at an extended and overbought sort of rally in bonds.

Saugata Bhattacharya: It is to an extent. I do not pretend to be a bond market expert. There is a lot of positioning in bond, in all of this. So I think there will be some part of a retracement of bonds from the 7 levels but I would not be surprised if at some point of time, it actually breaches 7. If yield comes in, if the repo rate goes to 6.25, this is still historically the spread, still historically very, very high. So there is room for them to compress even further.

The inflation data we will see in the next couple of days. I think that itself will cause some retracement and the CPI numbers are not likely to be good. That is close to 6%, maybe even breaching 6%. So if that actually comes in, that will cool the markets a little bit but beyond that you have already seen a fantastic rally. I expect the rally to continue but the rally still has to have some legs but I think we are near the bottom in terms of the benchmark yield till the expectation of, some certainty comes in of the next repo cut. Then it will come down again, probably another 25 bps fall in rate. And remember the other remarkable thing is that this is, we are just talking of the sovereign bond. Corporate bond spreads have tightened up. I do not know how many years this is…, the spread is so thin over the sovereign bond that is another bond to watch out for.

ET Now: Let us revisit the point you were making on the rate cuts? What is your expectation?

Saugata Bhattacharya: We can hypothesise on this. I think there is definitely room for another 25 bps cut. You remember the statement that the neutral rate where the repo rate can probably stabilise, that is at 150 bps over the one-year treasury. So the one-year treasury working backwards with a 25 spread over the repo rate with inflation likely to average round about 5% in FY18 the next year, going forward into the next year, a 6.25% is definitely feasible. Beyond that, how various factors play out -- commodities prices, oil, etc, then we can begin to question whether it can go do 6% or not. But we are waiting for the new MPC, the new analytics that will come in, etc, and then… but I think 6.25% is very much on the cards.

ET Now: I just want to touch upon how are you looking at the trend for inflation where you are saying yes it is expected to edge higher. But with a good monsoon towards the latter half of the year, inflation would again become a bit subdued and come in closer to the long term target that the RBI has stated. Tie that in with all that talk about growth recovery and growth momentum picking up from here?

Saugata Bhattacharya: Sure. So first inflation, We are likely to see a print close to 6 per cent, our own Axis Bank forecast is 5.98 per cent or thereabouts. Everybody knows about this as it is purely a base effect working in. Last year it was very low. So, for the next couple of months it is likely to remain high 5.8-5.6 or thereabouts, after which in October, November, December it is likely to come down till about January before it starts climbing out again. This more or less has factored in the effects of the rains, food prices coming down, pulses inflation coming down etc. So how well the markets respond to the monsoons will tweak the rate trajectory.

In terms of growth, even before that, structurally there are some factors that will keep inflation up one after the other. One, the payouts from the Seventh Pay Commission that is expected to boost demand, as is the monsoon expected to boost rural demand.

Once these begin to play out, then GST comes in. Commodity prices have started increasing slowly and that will have an impact on inflation, but let us see how things play out. Growth is still likely to remain subdued for the next couple of months, we are expecting an IPP print of about over 1% or so, but hopefully now with the good rains, in October and November when the first kharif harvest come in, we will probably begin to see a rural driven growth coming in from that side plus the impact of the payouts of the Seventh Pay Commission. So I think this time, we have been talking about the second half for a long time but sense that this time the second half will come into play, we will get some traction on growth.