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Rajeev Verma, vice president at the DSP Merrill Lynch, expects the 10-year yield to be at 8.5% by the year-end.
He says that loan growth is seen coming down to 23-24% for banks in FY07. Loan growth is seen below 20% for banks in FY08, says Verma.
He further says that while the demand is strong, rising lending rates will impact loan growth. Verma also expects a downturn in the Fed rate cycle by the year-end, and early 2007. Excerpts from CNBC-TV18's exclusive interview with Rajeev Verma:
How much more from here, do you reckon, would yields harden over a 6-12 month kind of period? Do you see real interest rates actually inching up quite substantially too as indicated by the Central Bank?
We are expecting rates to move up a bit more from here. It is hard to pinpoint the exact number, but probably they could be in the range of 8.25- 8.5% by the fiscal year end. It is a function of what happens to inflation. It is also a function of what happens to the global rate cycle.
There are a lot of external variables at play out here. But what we are really trying to look at is that in the banking space is there an implication of rising rates whether the rate is 8.5 or 8.3 or 8.6. The key implications are that we are obviously expecting some deceleration in loan growth for the sector as a whole.
Loan growth has been adding to about 30% till last year and we are expecting that to come down to 23-24% for this year. It could probably end a shade under 20% for next year, that is FY08. There could be some modest uptake in the NPL cycle.
We are probably in the best phase of the asset quality cycle and we think there could be some uptake there. However, we do think that is going to be probably a modest upswing in the NPL cycle, nothing like what we saw in the mid- to late-90s.
The one area where we still have some level of comfort is that on a normalised basis we think the margin pressure may still be fairly benign. We think banks will be able to push up both lending and deposit rates, so to that extent they should be able to have some margin protection.
One could have some timing mismatches quarter on quarter but on a normalised basis there should be some amount of margin protection coming from that. That is a kind of broad take on the sector.
The key thing in the short term would be interest rates, dynamics, which clearly impact bank earnings. Again in that space I would like to highlight that banks which have high proportion of the government security which is in the 'held to maturity' category is reasonably well hedged to rise in bond yields. While banks,
What concerns you most about loan growth going ahead that demand will slacken or that lending rates will just start pinching?
It is more to do with the rise in lending rates. Demand frankly is pretty strong. At the macro level we are still seeing an upswing in the capex cycle. We are still seeing infrastructure spend happening which will again be a trigger for loan demand, so I think demand is strong and what we are trying to build out is with rising lending rates there should be some deceleration in growth.
As I said earlier we are still looking at growth at 23-24%, so in absolute level we are talking of fairly strong growth but obviously lower from last year's levels.
Would you be downgrading banks then as a sector in the light of what your expectations on interest rates are this year?
Not really, I think that it is more of a timing issue; the sector has actually underperformed by almost 30% vis-a-vis the market, so I think over a next six-twelve months horizon, the sector could actually start to perform. So it is more a timing issue and we do not take day-to-day calls on this. I would take more a call on when interests rates start to peak and one gets comfort on interest rates, the banking sector should actually start to perform from there on.
You do not see yield softening below 8% at any point this year?
Yes, in the short-term, we do not see the softening of the interest rates. For that one needs to have both the global rate hike easing and one needs oil prices also to start coming down. Until we see those two events playing out, it is unlikely that we will see the rates softening.
What are your global strategists and economists telling you now at Merrill Lynch about what the Fed will do next because there is some linkage between rates here and rates there and what the Bank of Japan may do in its next meeting?
I guess that the jury is really out in terms of the Fed rate and maybe there is another 25 bps rate hike. But I guess that 18 months from today, we are expecting the Fed rates to be lower than what they are today but at some point we are expecting a down turn in the Fed rate cycle probably by end of this calendar or early next calendar.
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