Opinion: Expanded risk premium

In  a surprise move, RBI Governor Dr Urjit Patel resigned from office on Monday citing personal reasons. Needless to say, this comes as a huge surprise not only because of the gravity of the event but also owing to a view that a somewhat cordial way forward had been agreed upon at the last board meeting with respect to major points of difference between the central bank and the government. We highlight here first thoughts on implications.

*This expands India’s risk premium at least in the short term. Whether this widened risk premium remains or not will importantly depend upon the way forward. Thus, the simple common perception today is that there is intent to compromise the RBI’s independence in a variety of ways. The most important from a bond market perspective amongst these is the notion that the government wants large portions of RBI’s capital to step up fiscal spending. This notion and these perceptions need to be controlled. If the government is successful in doing this, then the current widening of risk premium may well prove temporary.

*If one has to look for silver linings, one can feel somewhat comforted that this is happening now when oil is down and US dollar has stagnated, and not in the harsh period of July-October. At the same time there is a twinge of regret / frustration as well to see the rupee back at 72-plus even after the substantial correction in oil and general stability in global macro.

*At the end of the day, from the bond market standpoint two things are critical:

First, the assumption that repo rate has peaked should hold: It must be remembered that there is a global context here as well. Thus the phase of unsynchronised recovery in play for most of this year may be morphing into one of a more synchronised slowdown. Recent more dovish Fed commentary as well as part inversions to the US yield curve also point to the fact that this narrative seems to be gaining strength. Besides, growth locally seems to be losing momentum as well partly owing to tighter financial conditions. All told then, we remain confident that one needn’t change the assumption and the repo rate has indeed peaked in this cycle.

Second, the current market expectation of abundant open market operations (OMOs) over Jan-March should remain intact: While there is nothing yet to challenge this assumption, it may get tested in the very outlier event that the ‘capital transfer from RBI’ theory proves to be true. However, one has to reiterate that the latest information in the public domain in this regard is that a committee is to be formed to assess an appropriate capital framework for the RBI. This means that the process will be structured and will get conducted over a period of time, as opposed to an ad-hoc large transfer that some are currently fearing.

All told then, the current bond positive framework largely remains intact. It is important to remember that there is a global context here as well which makes the theme more durable. It is now up to the government to do everything to restore the perceived dent in RBI’s independence and to compress this unfortunate widening in India risk premium that the unanticipated exit of the RBI Governor has brought about.

(The writer is Head–Fixed Income, IDFC Asset Management Company)