The Reserve Bank of India will hike foreign portfolio investors’ G-sec investment limits only towards end-2015 after the markets have priced in the anticipated September Fed rate hike, notes BofAML.

Indranil Sen Gupta and Abhishek Gupta of Bank of America Merrill Lynch in their June 10, 2015 research report titled: “Investorspeak: Waiting for Godot (aka….)” anticipate another 50bp cut in early 2016 by RBI.

Fixed income investors bullish on G-sec

During BofAMAL analysts’ meeting last week with fixed income investors in Boston and New York, they said everyone wanted to know when the Reserve Bank of India will hike FPI G-Sec limits. The analysts note a few investors have bought quasi G-secs as a proxy as their mandate doesn’t allow them to buy corporate sector. The quasis are part of the wider $51 billion corporate bond limit.

Gupta and Gupta point out that this segment remains the most vulnerable to a pull out if the Fed hike leads to a sell-off in EM bonds.  Hence, to that extent, they note a hike in FII G-sec limits that drains this money could paradoxically be far more stabilizing.  As can be deduced from the following table, $39bn of the $51bn limit is currently utilized and has been so since April this year, as debt inflows have stalled in the current fiscal year due to external volatility:

Stalled FII debt flows India

The analysts note most clients share their bullish view on G-secs on the back of Reserve Bank of India rate cuts and favorable demand-supply conditions. BofAML’s South Asia rates strategist, Rohit Garg, anticipates the 10 year to ease to 7% by March 2016:

Bullish on G-secs India

The BofAML analysts believe if the Fed delays rate hikes to December, one could witness a $5bn increase in FPI G-sec investment limits by July.

Reserve Bank of India to cut rate by 50bp in early 2016

During their last meeting with fixed income investors last week, the analysts were also asked how much more can the Reserve Bank of India cut.. Gupta and Gupta  anticipate Governor Rajan to pause to allow the markets to price in the Fed rate hike expected in September, and then cut 50bp in early 2016:

RBI's rate cut India

The BoAML team believe inflation is likely well set on to the Reserve Bank of India’s under 6% inflation target with global commodity prices stabilizing on Fed tightening and the INR stabilizing with RBI buying FX:

Inflation on track India

Touching upon investors’ doubt whether the Reserve Bank of India will hike rates if poor rains push up food inflation, the analysts note that one will not get clarity on the monsoons until July. Moreover, the weather service reduced the monsoon forecast to a poor 88% of normal.

Monsoon predictions India

Turning their attention to the question on how much the RBI can really sell to defend Rs65/USD, the analysts anticipate that the bank should be able to spend US$15bn to defend Rs65/USD. They have also looked at the impact on headline FX reserves due to cross-revaluation effect as USD reportedly only accounts for 58% of Reserve Bank of India’s total FX composition. By plugging in BofAML’s FX forecasts for December 2015, they anticipate that “actual” FX reserves will fall by $15bn to $335bn:

Cross-revaluation impact India