Growth Preponderance Over Fiscal Continues
In the backdrop of omicron and fear of more such waves in future, the finance minister presented FY23 budget which reflects continuation of pro-growth bias. Fiscal consolidation continues, albeit at gradual pace. FY22 fiscal deficit has been revised marginally upwards to 6.9% of GDP (BE: 6.8%) despite sharp rise in revenue receipts and acceleration in nominal economic growth. Increase over budgeted number in expenditure was accounted mainly for income support revenue expenditure like subsidies (food, fertilizer), MNREGA, etc, which was much needed in a pandemic affected economy. While Budget has projected fiscal consolidation of 50 bps at 6.4% of GDP in FY23, this is much slower than consensus expectations (6-6.25%). While absolute size of budget is huge, the main focus has been on capex indicating preference for quality expenditure. In fact, there has been major reduction in revenue expenditure (excluding interest payments). That said, the bloated fiscal balance sheet will have to be funded through huge market borrowings (~14-14.25 trn as against 10.5 trn in FY22). Globally, the government are indicating fiscal consolidation albeit at slower pace to support growth.
After growing robustly in 2Q FY22, hi-frequency indicators suggested that recovery was regaining traction in 3Q. Corporate sector has displayed resilience and bank credit growth is showing signs of gradual recovery. However, in January, India Manufacturing PMI was impacted albeit marginally led by loss of momentum due to sharp rise in infection due to Omicron and related mobility restriction. Same is replicated at global level – indicating impact of omicron on economic activities seems to be relatively milder. Going forward, supply bottlenecks, inflation and uncertainty regarding new version of virus might act as headwind to future outlook (India and Global). On domestic front, India GDP is projected to grow at robust 9.2%y/y (FY21: -ve 7.3%y/y) driven mainly by net exports and government spending. For FY23, economic survey has projected economic growth of 8-8.5%y/y indicating growth momentum to continue going into next fiscal year.
December 2021 Headline CPI print came higher at 5.59%y/y (Previous month: ~4.91%y/y). This was in lower than consensus estimate of 4.8% y/y. Sequential momentum in headline was in line with the seasonality. Core inflation declined a bit to 6.19%y/y (Previous: 6.21%y/y) mainly on favorable base effect and lower monthly momentum. While the headline number continues to be around RBI’s target, worsening global macros (in terms of sharp rally in crude, slow resolution of supply chain issues, pandemic related restrictions) and domestic factors (rising cost of production, pick-up in demand, volatile crude prices, telecom hike) are likely to keep prices elevated.
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.
Globally, most central banks have already embarked on the path of normalisation with many emerging economies already done with more than couple of hikes. Many advanced economies have started process of rate/liquidity normalisation. US Fed has clearly given indication of likely earlier and more rate hikes in 2022 and early start of Fed balance sheet contraction. After surprise hike by Bank of England in December, there are strong indication that it will hike in February. So normalisation seems way ahead for both advanced and emerging economies, with inflation now taking precedence over growth for policy makers.
Back home, RBI continued with its policy of gradual liquidity normalization and has already initiated the process to do major liquidity absorption through 14 days VRRRs (as decided in Dec policy).
April-December 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-December expenditure growth still stood at modest 11%y/y, driven mainly by capital expenditure. Robust revenue growth and muted expenditure has kept fiscal deficit at record low ~50% of budgeted estimates (Normal times: 100%-102% of BE). January GST print was buoyant at 1.4 trn (record collections for fourth consecutive month) indicating pick-up in economic activities. That said, on expenditure front, Government is confident of not just of meeting BE, but actually exceeding it (through excess expenditure on subsidy and income support measures).
India’s External Sector & Global Update
Crude rose sharply during the month on rise in geo-political concerns. While first half of the month saw brent at average US$82.29/barrel, it rose to average US$88.47/barrel in second half to close the month at US$90.95/barrel. That said, Crude has increase by 15% m/m in January, having implication for global growth and inflation. Given uncertainty related, the crude prices expected to remain volatile in near future.
In the bond markets, US treasury yields rose sharply during January on higher inflation print and more on hawkish Fed policy. It started month on negative note, taking cues from rising concerns about virus and rose sharply post Fed policy indicating early shrinking of balance sheet and early rate hike. The US 10 Yr Treasury bond yield started the month at 1.63%, touched 1.87% levels post policy and ease towards the end of month to close the month at ~ 1.79% (Dec end: 1.52%, Nov end : 1.58%, Oct end : 1.55%, Sep end: 1.52%, Aug end: 1.3%, July end: 1.24%). Dollar Index eased marginally after continuously appreciating over previous five consecutive months.
Back home, after depreciating in Dec, INR appreciated against dollar (Avg Jan: 74.34/US$ against Dec: 75.53/US$).
After witnessing net inflows in Aug-Sep, there has been net FPI outflows in 4Q CY2021. This trend was marginally reversed in January. The month saw marginal increase in forex reserves to US$634 bn by mid-month. YTD FY22 Forex reserves rose by US$57 bn.
Yield Levels & Spreads:
G-sec yields moved sharply on global cues (especially post US Fed policy, rising crude, rising geopolitical concerns) and domestic cues (sharp rise in omicron raised supply side concerns, fiscal concerns ahead of Budget). In fact, the yield curve is factoring in couple of rate hikes in FY23. Even the OIS curve & Tbill cut-offs (across maturities) has moved up reflecting tightening bias. The 10 Yr benchmark ranged between 6.46%-6.76% during the month, only to close the month at 6.69% (Dec end: 6.46%, Nov: 6.33%, Oct: 6.39%, July through Sep end: 6.20% - 6.22% range). In fact, slow fiscal consolidation and huge borrowings programme in Union Budget resulted in 15-20 bps yield hardening across the curve. That said, 10 year has been on rise over last couple of months reflecting global trends (rate and liquidity normalisation). In fact, 10 Term premium (10 yr over 365 days) eased marginally to average ~ 222 bps in Jan (Dec: 224 bps, Nov: 228 bps, Oct: 244 bps, Sep: 253 bps, Aug: 259 bps) on reduce steepness of yield curve.
Taking cues from G-sec, 10 yr SDL rose sharply and was in average ~7.14%, however, it closed month higher at 7.24% (Dec end : 6.99%, Nov end: 6.81%, Oct end: 6.92%, Sep end: 6.79%, Aug end: 6.88%, July end: 6.96%). SDL primary supply was Rs. 79,535 cr (Dec: Rs.54,385 cr, Nov: Rs. 43,502 cr, Avg Aug-Oct: 55,000 cr). The spread between 10 yr SDL over G-sec rose to 53 bps during the month as against average 47 bps in Dec (Nov: 54 bps, Oct: 57 bps, Sep: 61 bps, Aug:71 bps). Reflecting Gsec and SDL curve dynamics, AAA bonds rose across the curve. 10 yr AAA PSU closed the month at 7.10% (Dec end: 6.84%, Nov end: 6.88%, Oct end: 6.91%, Sep end: 6.80%, Aug end: 6.93%).
Core system liquidity (system liquidity + govt balances) has reduced over the time. From peak of 13 trn in Sep-Oct, core system liquidity at January end stood at ~11 trn (Dec end : 11.7 trn) on account of increase cash demand (CIC) and RBI’s action in G-sec market and currency market. With government balances running ~avg 4 trn, system liquidity was on average 6.2 trn during the month (Previous month: 7.5 trn). Going into last two months of financial year, the government balances are expected to be run down to meet fiscal deficit target and reflect in improved system liquidity. However, the CIC requirement (cash demand in line with seasonality) will be drain to overall liquidity.
As announced in Dec monetary policy, RBI has ensured that the daily deployment in reverse repo is reduced to minimal (current run rate : ~1 trn as against 2-3 trn before policy) and bank park excess liquidity with RBI mainly through VRRRs auction (cut-off generally at 3.99%) and 14 days VRRRs being used main instrument of sucking out liquidity. Interestingly post GST outflows, the overnight shot up and was in range of 4-4.25% for more than a week, on account of short covering on VRRRs (i.e. park more money with RBI than actual holding) and came down to normal levels towards month end on government’s spending.
- Omicron virus saw virulent rise and similar speedier decline in India. Although we are not out of woods and cases are still big in numbers, infection rate has reduced. Further, its impact on economic activities seems to be limited.. So barring virus related uncertainty, economic growth is gaining strength, although there has been a slowdown in momentum.
- Union Budget has given clear indication of fiscal support for growth to continue in coming years, while adopting gradual glide path for fiscal consolidation. Huge absolute fiscal deficit numbers and thereby borrowing numbers are likely to have an implication for bond market. Already 10 year benchmark has lost ~20 bps in last two days (1st and 2nd Feb, 2022) and yields have rose across the curve. So, demand-supply dynamics may be key to yield movement and RBI’s support mayplay a crucial role in supporting bond yields.
- Rate and liquidity normalisation across countries have resulted in a bit tightening of global liquidity scenario. This, plus Global cues (crude prices, US Fed rate hike cycle), 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/above reverse repo rate (trending below reverse repo post Covid on the back of humungous liquidity). February policy maybe an indicator of how and when RBI plan to approach rate and liquidity normalisation path, especially in backdrop of huge borrowing programme.
- That said, the current steepness in the yield curve along with absolute levels makes the outlook constructive for most debt funds
Bloomberg, RBI, CEIC, Finance Ministry of India, NIMF Research
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