Debt Commentary – October 2016
| ||31-Oct-16 ||30-Sep-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 subdued, for most part of the month, after the initial rally post the rate cut by RBI as the continued uncertainty on global factors weighed on market sentiments. Globally, markets were preparing themselves for the upcoming FOMC meeting and the US Presidential elections as both the events hold profound implications for markets. Tracking these cues, domestic sentiment remained subdued, as investors unwilling to take any major bet on rate movement, especially after the strong rally witnessed in the last couple of months. Nevertheless, the for the period under review, the 10year benchmark yield (new) eased marginally by 3 bps to close at 6.79%. The corporate bond yields remained range bound, with 10year AAA yields moving up by 2 bps, while the 5year AAA bond yields easing by 6 bps. The yields on the money market instruments at the shorter end moved up partly as a result of delayed response by RBI on liquidity easing through OMO. While the 3 month CD yields moved up by around 6 bps, the 1 year CD yields moved up by around 15 bps.
In the first monetary policy decision taken by the MPC, the benchmark Repo rate was lowered by 25bps to 6.25%, by way of a unanimous vote, with attendant changes in Reverse Repo and MSF rates. Factors such as better monsoon, supply management by the govt., at this juncture, outweighed the concerns regarding the pay commission award & its impact on inflation. The tone of the policy remained fairly consistent with recent reviews and acknowledges the opening up of space for policy action as a result of improving food inflation outlook while continuing to use liquidity provisioning as the primary conduit of monetary policy transmission. The MPC retained Mar’17 inflation target at 5.0% with risks tilted on the upside; however, lower than that witnessed in Jun/Aug’16 policy statements. The uncertainty & upside risks emanate from the impact of full implementation of wage hike & the GST rate. On the growth front, while the implementation of wage hike, normal monsoon and past monetary actions would bolster aggregate demand, domestic conditions are expected to improve gradually particularly at a time when global trade remains fragile. Thus, with risks evenly balanced on both sides, GVA growth projection was retained at 7.6%
On the macro economic data released during the period, September CPI printed at a 13-month low of 4.31% led by the anticipated disinflation in food but much lower than market expectations( 4.6%). A more than expected seasonal correction in food prices, driven by a normal monsoon after two consecutive years of deficient rainfall contributed to a lower food inflation print. Sequential decline in food inflation was broad based led by vegetables (-5.46%), pulses (-2.39%) and fruits (-1.45%). Protein based inflation declined by the largest amount since the release of the new series. Perishables also continued its downward trajectory aided by fresh supplies arriving in the market. We believe food price disinflation will sustain as better yield on account of normal monsoon along with higher area sown will further improve supply in the coming months. Core CPI continued to rise for the third consecutive month to 4.88% from 4.72% in Aug. However, Core core inflation (after excluding impact of fuel and precious metals) moderated to 4.72% from 4.82% in Aug. Two upward revisions in petrol and diesel prices during the month drove up core inflation. Monthly increase in petrol (3.8%) and diesel (2.5%) were the major contributors. Excluding commodity linked items (petrol, diesel, and precious metals); core core CPI witnessed its lowest figure in the new series. Core core CPI is more reflective of domestic non tradable services. Moderation in core core CPI is positive as it leads to lower inflation expectation in services. Cooling food prices also helped wholesale inflation decline to 3.57% in September after it touched a two-year high in August at 3.74%. Inflation at the wholesale level has moved down essentially on the back of receding pressures from the food basket. However, increase in Nonfood manufacturing prices for the third consecutive month indicating improving pricing power for producers.
The Index of Industrial Production contracted by 0.7% in August, on the back of weak mining and manufacturing sector production and a steep decline in capital goods. The index has contracted by 0.3% in the April-August period this year, in contrast to 4.1% growth recorded in the same period last year. Mining sector output plunged 5.6% in August from a year earlier while manufacturing production output fell 0.3% year-on-year. Capital goods production, an indicator of investment activity in the economy, fell 22.2% in August, in contrast to 21.3% growth recorded in August last year. During the April-August period, capital goods output shrank by 21.4%, against a growth of 7.2% in the same period last year. Consumer goods production grew just 1.1% in August from 6% ago, pointing to tepid consumer demand. During April-August 2016, cumulative growth in mining, manufacturing and electricity sectors has been 0.6%, (-) 1.2% and 5.7%, respectively, over the corresponding period of 2015. While the sluggish growth in the Industrial output is largely due to deceleration in private investment activity, growth momentum may pick up in coming months due to festive demand. Consumption demand is set to improve appreciably in the coming months, with the kharif harvest forecast at record levels, revised pay and pensions being implemented by the Central government and the impending festive season.
Going forward, with the food inflation expected to cool off further, we retain our view of another 25bps rate-cut in FY17. While there is slight uncertainty over the timing of another rate-cut, especially with the next policy review scheduled a week prior to the US Fed meeting, we expect it to be delivered at the February 2017 policy review, which we believe will be the last in the on-going easing cycle. We expect the 10Y benchmark to gradually advance towards the 6.50-6.60% band from the existing 6.70%-80% range, especially if the OMO purchase frequency is maintained and inflation readings continue to surprise on the downside.