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Debt Market

  • Jul 12, 2017

    Debt Commentary – January 2018

    31-Jan-18 31-Dec-17
    Change (bps)
    10 Year Benchmark Yield (s.a) 7.43% (new) 7.33% 10
    10 Year AAA (PSU) (ann) 7.96% 7.84% 12
    5 Year AAA (PSU) (ann) 7.74% 7.66% 8
    3 Month T Bill 6.40% 6.20% 20
    3 Month CD 7.20% 6.38% 82
    12 Month CD 7.46% 6.75% 71
    10 Year AAA Spread 0.39% 0.38% 2
    5 Year AAA Spread 0.17% 0.20% -2

    Sovereign bond market yields hardened due to rising crude oil prices, rising US treasury yields, concerns about excess borrowing through G-Sec and increasing expectations of rate hike going forward as CPI inflation hits 16 month high. Globally bond yields also hardened with US 10-year note hitting a high of 2.72 and closing the period at 2.70 versus 2.40 at the beginning of the period. For the period under review India 10-year G-Sec yields hardened by 10 bps and closed at 7.43, with the old 10-year trading at 7.58 % levels, an increase of 25 basis points. Corporate bonds also followed suite with 10-year and 5-year corporate bond yields up by 12 bps and 8 bps respectively. Money market instruments at the shorter end hardened because of financial year end crossing premium with 3-month treasury bill up by 20 bps and 3-month and 12-month CD yields up by 82 bps and 71 bps respectively. Net FPI inflows in Indian debt market stood at Rs. 8,522 crores for the month of January.

    Crude oil prices rose during the month on the back of reducing inventory surplus because of refinery maintenance and increasing demand of distillate because of cold weather and production cuts deal being extended till end of 2018 by OPEC and non-OPEC countries. Brent Spot closed the period under review at USD 69.05 after hitting a high of USD 70.53 versus USD 66.82 per barrel at the beginning of the period.

    On the macroeconomic data released during the period, December CPI inflation rose to a 16-month high of 5.21% from 4.88% in November and above market consensus of 5.10%. Rise in inflation was mainly due to higher food and fuel prices. Core CPI inflation also accelerated further for the fourth consecutive month to 5.2% from 4.9% in November. IIP rebounded to 8.4% in November from a downwardly revised 2% in October, led by an increase in consumer non-durables, infrastructure and capital goods segments. A few items may be exaggerating the underlying industrial strength, but the macro data suggest an industrial cycle recovery. WPI inflation for December moderated to 3.58% from 3.93% YoY in November. The surprise was mainly due to lower than expected food prices.

    Finance minister announced the Union Budget on 1st Feb wherein fiscal deficit target for FY19 was relaxed to 3.3% vs market expectation of 3.2% and FRBM roadmap of 3.0%. The government has adopted a revised FRBM target for fiscal deficit and now will pursue 3.1% for FY20 and 3% in FY21. Gross market borrowings for FY2019 are pegged at INR 6.06 trillion, as compared to INR 5.99 trillion in FY2018. The net market borrowing (g-sec and t-bills) for FY2019 stands at INR 4.07 trillion (as compared to INR 4.80 trillion in FY2018). Further government has also announced g-sec switch and buy-back of INR 280 billion and INR 719 billion respectively. Though the net borrowing number is broadly in-line with market expectations, the fact that fiscal prudence targets have been relaxed, along with likelihood of steep MSP hike for Kharif crops, there is a likelihood that this might lead to inflationary pressures and result in RBI changing policy stance. This was also evident from the sharp reaction in the bond market after the budget announcement.

    Systemic liquidity remained easy over the month and closed the month positive at Rs. 19,700 crs vs a surplus of Rs. 22,200 crores at the beginning of the period. Liquidity is expected to remain in negative to neutral zone going forward in Q4FY18. RBI will actively manage liquidity by OMO, MSS etc. as indicated during the Fifth monetary policy meeting.

    Going forward, we expect CPI to settle around 5 % by Q4FY18. We expect the RBI to stay on hold in its February policy. We don’t expect any further rate cuts by RBI and given the current inflation trajectory and global developments (firming up of crude & other commodities and hardening of Developed Market bond yields) RBI might be forced to adopt a more cautious stance going forward and rate hikes can come sooner than earlier envisaged if global environment continues to remain unfavorable. We expect 10-year G-sec yield to trade range-bound in near term, within a band of 7.40%-7.70%. We expect liquidity to remain negative going further and RBI to actively manage liquidity by OMO and MSS. Short term rates which increased due to tightening liquidity and march crossing premium will take cues from the liquidity conditions going forward.

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