Factsheet Index
Fixed Income
Market Update
and Outlook
Market Update
Evolving Growth, Inflation & Rates Dynamics in backdrop of rising uncertainty related to Virus
Economic Growth:
Indian economy grew at robust 8.4%y/y in 2Q (July-September) FY22 driven by broad-based recovery in consumption, capex and buoyant trade – indicating recovery is underway. Second quarter saw reduction of pandemic related restrictions, improvement in mobility and opening up of services sectors. Pent up demand especially for services, government spending (revenue as well as capex) were key drivers of growth. Most of hi-frequency indicators from supply as well as demand side are at/above pre-pandemic levels. Only Government spending on demand side and construction and trade, transport and communication on supply side are below pandemic levels. Going forward, services and construction are likely to lead the growth in coming quarters driven by pent up demand. That said, supply bottlenecks, inflation and uncertainty regarding new version of virus might act as headwind to future outlook (India and Global).
Inflation
October 2021 Headline CPI print came bit higher at 4.48%y/y (Previous month: ~4.35%y/y). Despite favorable base effect in play, the broad-based sequential increase in major components of index pushed up the inflation. After consecutive three months of decline, Core inflation rose to 6.17%y/y (Previous: 5.86%y/y). While the headline number still continues to be within RBI’s target, unfavorable base effect, worsening global macros (in terms of sharp rally in commodities, supply chain issues, pandemic related restrictions) and domestic factors (rising cost of production, pick-up in demand, higher crude prices and telecom price hike) are likely to keep prices elevated in coming months. Downside risk is likely to come from seasonality in vegetables and fruits, fuel tax cut, etc.
Globally, consistently over last couple of months, the inflation has been showing northward trend - driven by base effect, pick-up in economic activities, broad-based supply issues, rising food, commodities, manufacturing and services prices. In fact, over last couple of months, Inflation has sharply increased in US, Europe & UK. Inflation has been on uptrend across emerging economies. Now with the new virus, supply side issues are likely to persist for longer making higher inflation more entrenched.
Monetary:
Globally, most central banks have already embarked on the path of normalisation with many emerging economies (mainly outside Asia) already done with more than couple of hikes. Many advanced economies have started process of rate/liquidity normalisation. US Fed has already embarked on the path of liquidity normalisation. Recent hawkish speech of Fed Governor clearly indicates notwithstanding the uncertainty related to new virus, Fed is already thinking of rate normalisation sooner than later.
Back home, consensus is building up of reverse repo hike in Feb policy in global backdrop of rate normalisation, improving domestic macros, rising pricing pressures and persistent supply issues. RBI has already embarked on path of liquidity normalisation by increasing amount under various reverse repo auctions and conducting longer maturity reverse repo auctions to reduce daily surplus liquidity overhang.
Fiscal:
April-October fiscal print continued to assert robust revenue growth (driven primarily by tax revenues & RBI dividend) reflecting domestic recovery, increased formalisation of economy and reduced tax evasion. While expenditure growth picked up from August onwards (both revenue and capex). April-October expenditure growth still stood at modest 10%y/y. Robust revenue growth and muted expenditure has kept fiscal deficit at record low ~36% of budgeted estimates (Normal times: 95%-100% of BE). November GST print was buoyant at Rs. 1.3 trn (record collections for second consecutive month) indicating pick-up in economic activities. That said, Government officials have been asserting that back-loaded expenditure, lower disinvestment collections and more off-budget items brought above the line in the budget are likely to ensure elevated FY22 fiscal deficit.
India’s External Sector & Global Update
Crude continued to remain elevated in the first half of November but declined sharply in second half of the month on rising concerns about the new virus Omnicron. While first half of the month saw brent at average US$83.16/barrel, it was average US$78.38/barrel in second half to close the month at US$69.75/barrel. That said, Crude has increase by 57% in current calendar year, having implication for global growth and inflation. With winter and festive season approaching and no major supplies expected, the crude prices are expected to remain volatile in near future. Major six countries US, UK, Korea, Japan, China and India have released 10% of their strategic reserves in market to reduce the crude prices, yet this decision failed to influence the global crude prices.
In the bond markets, US treasury yields remained volatile during November. It started the month on negative note, taking cues from elevated crude prices, high inflation and expectations of early & quicker reversal of Quantitative Easing (QE). As expected, Fed announced reversal of QE, but amount was lowered than market expectations, resulting in yield easing post policy. Rising concerns about the virus kept financial market including US treasury yield volatile. The US 10 Yr Treasury bond yield started the month at 1.58%, touched 1.63% levels by mid-month, declined thereafter on virus concerns to close the month at ~ 1.58% (Oct end: 1.55%, Sep end: 1.52%, Aug end: 1.3%, July end: 1.24%). Dollar Index continued to appreciate for fourth consecutive month.
Back home, after depreciating by ~2% in October, INR appreciated marginally against dollar (Avg Nov: 74.51/US$ against Oct: 74.92/US$). However, it appreciated towards the end of the month on global cues and strong dollar on rising risk aversion amid new virus concerns.
After witnessing net inflows in Aug-Sep, there was net FPI outflows in Oct (~US$1.7 bn) and marginal outflow in Nov (~US$0.3 bn), driven mainly by equities. November saw forex reserves decline a bit to US$640 bn by mid-month. YTD FY22 Forex reserves rose by US$63 bn.
Yield Levels & Spreads:
G-sec yields started on negative note on global cues (US and UK normalisation plans, rising US treasury yields, strong dollar index), but eased post Fed policy on lower than expected tapering amount. It however rose a bit on inflation data, thereafter it remained volatile tracking US yield and crude prices. It eased toward the end of month on rising concern about the new virus. The 10 Yr benchmark ranged between 6.29%-6.39% during the month, only to close the month at 6.33% (Oct: 6.39%, July through Sep end: 6.20% - 6.22% range). Term premium (10 yr over 365 days) eased to average ~ 228 bps in Nov (Oct: 244 bps, Sep: 253 bps, Aug: 259) on reduced steepness of yield curve.
Taking cues from G-sec, 10 yr SDL was on an average ~6.89%, however, it closed month lower at 6.81% (Oct end: 6.92%, Sep end: 6.79%, Aug end: 6.88%, July end: 6.96%). SDL primary supply was lower at Rs. 43,502 cr (Avg Aug-Oct: 55,000 cr). The spread between 10 yr SDL over G-sec narrowed further to average 54 bps in Nov (Oct: 57 bps, Sep: 61 bps, Aug:71 bps). Like SDLs, AAA bonds took cues from G-sec. 10 yr AAA PSU were range-bound and closed the month at 6.88% (Oct end: 6.91%, Sep end: 6.80%, Aug end: 6.93%).
Common Source:
Bloomberg, RBI, CEIC, Finance Ministry of India, NIMF Research
Market View
  • Rising concerns about new virus leading to lockdown like situation in Europe and many parts of the world is raising concern about growth on one hand and elevated crude and commodity prices, supply chain disruptions have implications in form of higher inflation on the other hand. Already Inflation in many parts of the world is at multi-year high and many emerging economies have already switched to normalisation path, with advance economies joining sooner than expected. US Fed has raised its concerns that inflation no longer being transitory and is likely to hike sooner than later. Global cues, domestic development (improving growth prospects) along with new virus variant has led to a lot of uncertainty for RBI.
  • RBI has already embarked upon the path of Liquidity normalisation. Overnight rates are at reverse repo rate (trending below reverse repo post Covid on the back of humungous liquidity). We expect RBI to embark on the path of normalisation by raising reverse repo in Feb policy.
  • Going forward, yield curve is likely to be supported by improving fiscal position of the government, despite cut in excise duty. Government is likely to adhere to the budgeted fiscal numbers, by back-loading expenditure to support growth.
  • The current steepness in the yield curve along with the RBI policy makes the outlook constructive for most debt funds.
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