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Debt Market

  • Jul 12, 2017

    Debt Commentary – July 2017

    31-Jul-17 30-Jun-17 Change (bps)
    10 Year Benchmark Yield (s.a) 6.47% 6.51% -4
    10 Year AAA (PSU) (ann) 7.34% 7.43% -9
    5 Year AAA (PSU) (ann) 7.15% 7.32% -17
    3 Month T Bill 6.13% 6.13% -16
    3 Month CD 6.18% 6.33% -15
    12 Month CD 6.57% 6.63% -6
    10 Year AAA Spread 0.77% 0.81% -5
    5 Year AAA Spread 0.58% 0.70% -13

    The month of July saw corporate bonds and state government securities outperforming the government securities markets. Most of the activity was concentrated in the less than 10year segment as market players moved from liquid papers to semi liquid papers due to attractive carry available in these papers compared to overnight call money rates. 10year corporate bond and state government securities spread over 10year benchmark has compressed to 60 basis points from 70 basis points prevailing in the beginning of the year.

    However, the month of July had its own set of volatility as RBI started Open Market Operations (OMO) to control excess liquidity in the system due to its forex purchases. RBI has been forced to step up dollar purchases due to dollar index trading at 93 levels from 96 levels at the beginning of the month. RBI OMO was well bid by the market as most market players expected RBI to cut rates by 25 to 50 basis points in its monetary policy on August 2, 2017. RBI has forward dollar purchases of INR 17 billion which should lead to higher Market Stabilization Scheme (MSS) and OMO in the coming months to take care of the excess liquidity in the system.

    CPI inflation for the month of June was at 1.54% with food inflation being negative on a year on year basis. The core inflation which strips out the effect of food inflation and fuel was at 3.82%. Both headline inflation and core inflation was below the CPI target of 4% set by RBI to be achieved in the current financial year. With south west monsoon being at 101 % of the long term average and sowing 3.3% higher than last year, rate cut was a certainty. Capacity utilisation in the industrial sector is at 74% and the Indian currency appreciation has made imports cheaper reducing the pricing power of the manufacturers. The current account deficit for the period April to June was at 40 Billion USD which is more than double of last year as imports grew in double digits and exports in single digits.

    RBI in its monetary policy cut the repo and reverse repo rates by 25 basis points. RBI maintained its neutral bias in its credit policy and stated that most of the concerns of inflation has not materialized or its intensity has reduced. However, RBI also highlighted the risk due to farm loan waiver, states may have to reduce capital expenditure. Rural demand is expected to increase due to good monsoon which could put pressure on CPI inflation.

    RBI Deputy Governor has indicated in its post policy meet of keeping real interest rates at 1.75%. Real interest rate is calculated as the difference between one year treasury bill and expected CPI inflation after one year. Real interest rates in developed world and in countries having sound macroeconomic policy is less than 1% due to deficiency in Demand conditions. RBI expects CPI inflation to be just above 4% in March 2018 as per its projections. This will allow RBI to cut rates one more time either in October or December 2017.

    RBI is right in being cautious due to global uncertainty with Fed and ECB expected to reduce the balance sheet. RBI has projected GDP growth to be 7.3%, which is difficult to achieve. Credit growth has not picked up and is running at 6.1% levels even after banks are flushed with liquidity to the extent of Rs. 2.5 trillion. Interest rates in the banking system needs to go down significantly for credit growth to pick up. We expect RBI to cut rates by 50 basis points in the coming months as we expect CPI inflation will be below 4 % by March 2018 due to the global deflationary environment prevailing in the world economy.

    Bond markets are expected to be well bid and the 10year government security yield is expected to trade in the band of 6.25%- 6.45% in the coming months. There would be demand for semi liquid papers and corporate bonds due to higher yields available in these papers compared with the liquid government securities.

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