Debt Commentary – December 2016
| ||31-Dec-16 ||30-Nov-16 ||Change (bps) |
|10 Year Benchmark Yield (s.a)
|10 Year AAA (PSU) (ann)
|5 Year AAA (PSU) (ann)
|3 Month T Bill
|3 Month CD
|12 Month CD
|10 Year AAA Spread
|5 Year AAA Spread
Sovereign bond market remained volatile throughout the month, after initial rally the market witnessed a massive sell-off as RBI maintained status quo on policy rates against the market expectation of 25 bps rate cut. Globally, bond yields continued to rise post US FOMC meeting which was more hawkish than expected and expectations of increased fiscal spending. USD continued to strengthen against most currencies, which caused hardening of yields in most global markets on account of outflows. Crude prices continued to inch up on account of OPEC deal to limit production.
For the period under review, the 10 year benchmark yield hardened by 28 bps to close at 6.52%. The corporate bonds also followed G-Sec, with 10 year AAA yields up by 38 bps, while the 5 year AAA bond yields were up by 45 bps. The yields on the money market instruments at the shorter end also hardened as RBI announced measures to manage the excess liquidity in the system. While the 3 month Treasury bill hardened by 25 bps, CD yields hardened by 13 bps and 15 bps in 3 month and 1 year segment respectively.
The Reserve Bank of India (RBI) in its 5th bi-monthly monetary policy, maintained HOLD on key rates (the Repo rate and the Reverse repo rate). This was much against market expectations, which had an almost consensus view of 25 bps rate cut with some even not ruling out a 50 bps cut. The rate decision has been taken by a six-member monetary policy committee (MPC) with all 6 members voting for a hold on rates. The MPC took note of rising and sticky prices of large portion of CPI index that is masked by easing of inflation on base effect during October. As base effect wanes-off, the overall CPI number could start inching up again. Also, with OPEC agreement to cut production, there is a possibility of crude prices going up. MPC also took cognizance of global financial markets volatility post outcome of US elections, which could impart volatility to exchange rate thereby feeding inflation.
On the macro economic data released during the period, November CPI printed at a two year low of 3.60% YoY, from 4.20% in October. The fall in inflation was mainly driven by food inflation which fell sharply to 2.56% YoY compared to 3.71% YoY last month. In sequential terms, CPI fell by 0.15% MoM mainly due to sharp fall in vegetable and fruit prices. Food and beverages (weight of 45.86% in CPI) grew by 2.56% YoY during the month compared to 3.71% in October. On the other hand, core inflation remained flat at 4.98% YoY but increased 0.32% MoM. Core-core inflation (excludes petrol and diesel prices) dipped lower to 4.8%YoY, from 4.9%.
The Index of Industrial Production contracted by 1.9% YoY in October vs positive 0.7% in September, on the back of seasonal factors (Diwali) and contraction in capital and consumer non-durable goods production. Weak private and public sector capex demand and subdued rural demand conditions continue to keep production levels subdued, with the IIP contracting by 0.3% in FY17(Apr-Oct) vs. a rise of 4.9% in the corresponding period in FY16. Mining sector continued to contract for the third consecutive month, reflecting the contraction in coal, crude oil and natural gas output. Mining sector output growth slumped 1.1% during the month compared to a plunge of 3.1% in September. Capital goods production, an indicator of investment activity in the economy, fell 25.9% in October, in contrast to a plunge of 21.6% in September. Consumer goods production contracted by 1.6% during the month compared to a growth of 6% in September.
Going forward, we expect inflation would be around 4.60% by March 17 compared to RBI target of 5%. However, Core inflation still remains elevated at close to 5% and not much downside is expected going forward. Thus a steeper and sustainable fall in CPI is much difficult. We expect one final 25 bps rate cut (uncertain on timing) but anything beyond that looks highly difficult. We expect 10yr G-sec to remain range bound around 6.30% - 6.50% in the near term.