Debt Commentary – February 2017
| ||28-Feb-17 ||31-Jan-17 ||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 witnessing a massive sell off as RBI announced a change in stance from accommodative to neutral. Globally, bond yields remained volatile with US 10 year trading in the range of 2.32-2.52 and closing the period at 2.39. For the period under review, the 10year benchmark yield hardened by 46 bps to close at 6.87%. The corporate bonds also followed G-Sec, with 10year AAA yields up by 45 bps, while the 5year AAA bond yields were up by 30 bps. On the contrary, yield movement on the money market instruments at the shorter end was a mixed bag because of excess liquidity in the system. While the 3month Treasury bill rates eased by 10 bps, 3month CD yields hardened by 5 bps and 1year CD yield eased by 1 bps.
The Reserve Bank of India in its 6th bi-monthly monetary policy, maintained HOLD on key rates and changed the monetary policy stance to ‘Neutral’ from ‘Accommodative’. Although market was divided on policy rate cut, with a section expecting a 25bps cut, the change of stance by RBI took market by surprise. The rate decision has been taken by a six-member monetary policy committee (MPC) with all 6 members voting in favor of monetary policy decision. RBI has taken note of persistence of inflation, excluding food and fuel, and has reiterated that stickiness in core inflation could set a floor on further downward movements in headline inflation. RBI expects inflation to pick up in H2-FY2018 and hence with the objective of achieving the medium term target of 4% within a band of +/- 2%, has adopted neutral stance of monetary policy.
On the macro economic data released during the period, January CPI printed a series low of 3.17% YoY, from 3.41% YoY in December. CPI inflation fell for the 6th consecutive month driven mainly by fall in vegetable and pulses prices. In sequential terms, CPI fell by 0.08% MoM due to sharp fall in vegetable and pulses prices. Outsized decline in perishable items was the key driver, with vegetables declining 4.71% MoM. Food and beverages (weight of 45.86% in CPI) grew by 1.29% YoY during the month compared to 1.98% in December. On the other hand, Core inflation rose to 5.2% YoY in January versus 4.90% YoY in December.
January WPI inflation rose to a 30-month high of 5.2% YoY compared to 3.39% YoY in December, beating market expectation of 4.35%. The acceleration was driven by higher input costs (non-food primary articles, minerals, fuel, basic metals), which more than offset the tepid food inflation reading (barring sugar) caused by demonetization.
Going forward, we expect inflation to be around 4.60%-4.70% by March 2017 and RBI target of 5.00% to be comfortably met. Core inflation has worryingly remained sticky around 4.5%-5.0% for past 1 year. However, the upward momentum in core inflation seems to be ebbing. We expect that liquidity will remain easy and RBI may give one final 25 bps rate cut either in February or April monetary policy. We expect 10yr G-sec to remain range bound around 6.30% - 6.50% in the near term.
The Index of Industrial Production moderated to -0.40% YoY in December from 5.70% YoY in November, below consensus of 1.2%. The moderation is not a surprise; weak demand since demonetization has likely forced companies to cut production in order to clear the excess inventory. Output growth contracted in consumer goods (more in durables than in non-durables), capital goods and intermediate goods segments, suggesting that both consumption and investment demand weakened after demonetization. 2016 has been a disappointing year for the industrial sector, with output growth almost flat at 0.3% y-o-y versus 3.2% in 2015, due to weak investment and external demand.
Central Statistics Office (CSO) released second advanced estimates of FY17 GDP, estimating real growth at 7.1% significantly higher than the market consensus of 6.8%. The reading remains unchanged vis-a-vis the first advance estimate, which is surprising as the impact of the ‘currency swap’ process wasn’t captured in the previous release. GDP growth for Q3FY17 which was supposed to capture the ‘currency swap’ exercise disruption was reported at 7.0% higher than the market consensus of 6.1%. Going further, the third provisional estimate due on May 31 might reveal the full impact of demonetization.
Going forward, we expect inflation would be around 4.00%-4.50% by June 2017 and RBI target of 5.00% to be comfortably met. On the policy front, we believe that change of stance from accommodative to neutral means that floor of policy rates has already been achieved and we may enter into a phase of prolonged pause in policy rates going ahead. We expect 10-year G-sec yield to trade range-bound in near term, within a band of 6.70%-7.00%. We expect liquidity to remain comfortable and in surplus mode for a few months going ahead which will limit upside in short-term rates.