The rise in oil prices owing to the situation in the Middle East could pose a microeconomic challenge for India as the nation's trade deficit may widen by $10 billion to $25 billion, two experts have said. But the issue is unlikely to impact rupee, bonds and monetary policy, they say.

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In an exclusive interview with CNBC-TV18, Hitendra Dave, head of global banking and markets at HSBC India, and Suyash Choudhary, head-fixed income at IDFC MF, voiced their views on the fiscal deficit, RBI rate cut, and bond yields.

Edited excerpts from the interview:

How do you look at fixed income and bond yields? Do you think yields will go higher?

Dave: I think the developments have been fairly recent, my guess is most people are waiting for clarity in the Union Budget--which way the government chooses to go towards the fiscal deficit whether they stick to the glide path or going to use government expenditure to support growth. So, I think 4-5 basis points (bps) here and there is not that much of an issue.

I think the main issues will be around which way inflation trends and which way growth trends.

The big talking point is the impact that the surge in crude would have on macros like inflation. What is your guestimate in this?

Choudhary: Most of the factors that are causing inflation today, they are largely pertaining to the supply side.

So, obviously, if we were to take an extreme view on crude, the situation in the Middle East continues to escalate and crude settles somewhere between $80-90 a barrel – that’s not a view, it’s just a scenario--then we have a bit of a macroeconomic challenge on our hands, but till very recently or even now the worry is lack of aggregate demand in the system and we can’t worry about both problems at a time, which are higher inflation and lower aggregate demand.

The latter implicitly meaning that the economy is growing below trend. So, the real question on the table is enough happening for RBI to start to reduce or eliminate the aspect of countercyclical monetary policy and if that continues to be in play then I think we are relatively okay, bond yields should remain stable given that term spread targeting for the first time by ‘Operation Twist’ is on the table.

I want to ask you what happens to the currency. At 72.10, do you think we should worry about rupee fall? People are talking about even 74 if crude were to rise.

Dave: Contextualise the numbers and then you take a call whether the currency will be weakened and if so how much.

We import $10-11 billion a month so let us say $120-130 billion of oil a year. At 10 percent, higher your trade deficit widens by $10-12 billion a year, at 20 percent higher the trade widens by $25 billion a year.

This assumes that the higher payouts that we make for oil consumption are not offset by lower imports in some other goods and commodities. I think this is the scale of challenge that your trade deficit could widen by a minimum of $10 billion and a maximum of $25 billion.

Will that cause a significant re-rating of the currency? I am not very sure about that.

I think we also need to fundamentally understand that in the previous cycle of higher oil prices, let us say pre-dating 2015 when oil prices were liberalised, this was a serious macro issue because we were all sheltered as consumers, the entire pain was taken by the fiscal, the fiscal-funded the subsidy by way of borrowings, that led to higher inflation concern, the central bank got active, the rating agencies got active, now as a country by and large our reaction will be similar to what is happening in the West.

What do you think the next step from the RBI could be? I mean is there any scope for further cuts, what are you expecting in the next policy?

Choudhary: It’s difficult to go for a cut right now; even before this escalation in oil prices the near-term CPI prints courtesy food and specifically vegetable inflation were looking on the higher side.

So, the print that is due this month will probably be in the area of 6.75 percent odd and the next print also, unless onion prices collapse sharply, will probably be higher than 6 percent and to the credit of the governor there is a very large clarity of thought that he is putting on the table and he is saying that we are very likely to see through this and there is space for accommodation that continues.

Now, better this recent escalation takes away that space in the near term is what one has to watch for.

Remember also globally higher oil prices will probably trigger more growth concerns right now than anything else because at the end of the day and like I referred to earlier it is a supply shock in a relatively weak global economy.

So, I would assume that even forecast with respect to let us say US GDP would start to get trimmed should oil persist where it is for a long period of time.

More than just intervening through rate cuts the Reserve Bank has been intervening through liquidity. We were hoping for liberal open market operation (OMOs) will be announced when the real fiscal deficit is announced in the Union Budget. Now, does that print and spend elbow room gets squeezed for the fear that foreigners will leg it out?

Dave: Two parts to this--one is, it is very pleasing as market participants to see finally RBI recognise that liquidity does have a rule. Historically, we have all struggled with trying to persuade RBI that there is an interest rate part which impacts yields and market activity levels but there is also the liquidity.

I think the amount of liquidity which has been retained in the system is Rs 2,00,000 crore on days upwards of Rs 4,00,000 crore and which very clearly is a recognition that liquidity is going to aid not just the rate cuts but also the transmission angle and you can see that at the absolute short-end up to three-four years when rates come down to historic lows. I have no doubts at all that should this amount of liquidity be retained for a few more weeks.

I think, you will begin to see it creep up the yield curve plus also creep outside the sovereign bond into the investment grid and, thereafter, into the next round so that part is I think there.

Your question on whether they can continue to do OMOs or I don’t think with liquidity surplus being what it is it will be denting RBI credibility to outright OMOs and the Twist Operations. I think, it is perfectly okay. You look at what central banks have done around the world to support growth, you have to say that RBI has actually been much more conservative than almost any other central bank of major economies and therefore and the scope in the Twist Operations is much larger.

Will foreign tolerance at some point become a problem? I mean the RBI could do what it is doing and I think it is determined to do Operation Twist and do other ways in which to help growth. But at some point -- look at the way a rating agency or a foreign institutional investor (FII) may look at it that is what I want from you as a point of interpretation. Will FIIs wonder inflation going up, growth is slowing, monetary and fiscal loosening at its worst, if they leg it out should we worry about that part and that constraining future OMOs, or at least immediate in the next six months?

Dave: No, I don’t think so, rating agencies if at all have to react. I am sure they will wait for the Budget numbers. Look at the credibility of the numbers and look at the expansion if any on the fiscal side.

I think central bank action which has been done all around the world without rating agencies reacting to it, what I think is a perfectly legitimate activity when you believe that your rate cycle is close to its low cycle you have to use other tools and then to use those tools can’t be a ground. I can’t speak for rating agencies, but I don’t think most foreign portfolio investment (FPIs) will be particularly bothered by the central bank action.

Come in on the point that Hitendra Dave was making about the expectation on the fiscal path in the Budget because many equity market watchers are okay with the fact that if the fiscal deficit targets are lessened. There is no fixation on that particular number so that a lot more money or some of the money can be spent on infrastructure development boosting, etc. What is your own view and what are you expecting in terms of the fiscal deficit numbers?

Choudhary: First of all I think probably our fiscal problem gets misdiagnosed in our view from time-to-time, so one of the worries that we often express and we have as well is that the effective public deficit is around 8.50 percent of GDP.

Now, the point to remember is that private sector or intermediary balance-sheets have been compromised for now probably 7-8 years and, therefore, from a macro standpoint if the sovereign were to intermediate credit via its own balance-sheet it makes perfect macro sense.

The other way to look at it is that 8.50 percent public deficit has happened and despite that we have hit 4.50 percent growth rate. So, by no means I would argue that public deficit contributed to the traditional macro imbalances that we worry about which is higher inflation and higher current account deficit.

First Published:Jan 6, 2020 7:00 PM IST