Factsheet Index
Fixed Income
Market Update
and Outlook
Market Update
October 2021: Normalisation of rates and yields (Global & Domestic), stagflation concerns & evolving pandemic trends
Economic Growth:
Rising headwinds in form of supply disruptions, elevated and rising commodities (especially crude) has resulted in growing concerns about stagflation globally. Inflation has been on rise for last couple of months now, with most Central Banks from emerging economies (with exception of Asia) already on path of normalisation and many advanced economies planning to join them. These factors along with supply issues are proving drag on growth. Covid cases, which have sharply declined in September, has again shown trend of picking up in various parts of world, proving to be additional headwind to growth. IMF, in its latest report, has revised down the global growth – driven mainly by markdown in projections for advanced economies and ASEAN countries (Delta effect). In fact, lower than consensus 3Q (July-Sep) GDP print of USA and China corroborates the slowdown of growth momentum
Back home, with minimal Covid cases seen and maximum opening up, most hi-frequency indicators are back to pre-Covid levels since Aug end-Sep indicating broad-based recovery led by rural demand. Pent-up demand and festive season provided boost to the domestic demand. Strong GST collections & robust tax collections indicates pick up in overall economic activities.
Inflation
September 2021 Headline CPI print came lower at 4.35%y/y (Previous month: ~5.30%y/y). While there was favourable base effect in play, the headline print came better than consensus expectations (4.5%y/y) – indicating that the sequential momentum continues to come down (especially food, housing and services). In fact, this is fourth consecutive month of lower than consensus print. Core inflation moderated to 5.85%y/y (Previous: 5.89%y/y) mainly on favourable base effect and lower uptick in housing and services inflation. Sharp rise in transportation and fuel prices (in line with global trends) proved to be upside risk to overall inflation.
Globally, over last couple of months, the inflation has been showing upward pressure - driven by base effect, pick-up in economic activities, broad-based supply issues, rising food, commodities, manufacturing and services prices. In fact, Inflation is stabilizing at higher levels in US, picking up in Europe & UK. Baring China, Inflation has picked up across emerging economies.
Monetary:
With hi-frequency indicators signaling pick-up in economic activities and improved vaccination coverage, RBI, in October 2021 meeting, decided to continue with its approach of calibrated steps towards liquidity normalization, while keeping policy rates unchanged. RBI decided to increase VRRRs (Variable Reverse Repo Rate) amount from 4 trillion to 6 trillion and also increase maturity of VRRRs to 28 days. With this, RBI planned to maintain the liquidity available for daily fixed reverse repo rate auction at ~2-3 trillion (at time of policy: Rs.4 trn). RBI did not announce any quarterly G-SAP (Government Securities Acquisition Program) calendar (as has been trend since April 2021 policy). Recall that G-SAP auction has been major support to G-sec yields in 1H FY22 (Rs. 2.2 trn). Given the current liquidity overhang, absence of any additional Gsec borrowing for GST compensation) and in anticipation of increase in liquidity on account of expected government spending, the RBI has decided against any calendar for current quarter.
Globally, there is a rising trend towards normalisation of monetary policy (as evident since mid of 2021). Most emerging economies (mainly outside Asia) have hiked the rate and are on path of normalisation. In October, Brazil and Russia continued to aggressively hike the rate on backdrop of sharp rise in inflation. Couple of Emerging European countries also continued to normalise in October.
Fiscal:
April-September fiscal print continued to assert robust revenue growth (driven primarily by tax revenues & RBI dividend) reflecting muted second wave impact, increased formalisation of economy and reduced tax evasion. While expenditure growth picked up from August onwards (both revenue and capex). April-September expenditure growth still stood at modest 10%y/y. Robust revenue growth and muted expenditure has kept fiscal deficit at record low ~35% of budgeted estimates (Normal times: 90% of BE). October GST print was record high at Rs. 1.3 trn indicating pick-up in economic activities.
India’s External Sector & Global Update
Crude continued to witness sharp rally in October and were at record levels for most part of month. Starting the month at US$79.55/barrel, Brent breached record levels of US$86/barrel mid-month, only to close the month at US$84/barrel. Brent crude rose by 12.1% m/m in October (average US$83.65/barrel as against 74.6/barrel in Sep). While first half of the month saw brent at average US$82.65/barrel, it was average US$84.5/barrel in second half amid robust demand and OPEC countries deciding to stick to their previous supply schedule. Crude has increased by 70% plus in current calendar year. With winter and festive season approaching and no major supplies expected, the crude prices expected to remain elevated in near future.
In the bond markets, US treasury yields were volatile with upward trend during the month, taking cues from commodity prices (especially crude), Fed minutes, rising concerns about stagflation, growth print. The US 10 Yr Treasury bond yield started the month on positive note, touched 1.7% levels by mid - month, only to close the month at ~ 1.57% (Sep end: 1.52%, Aug end: 1.3%, July end: 1.24%). Dollar Index continued to appreciate for third consecutive month.
Back home, after appreciating in Aug-Sep, INR depreciated by ~2% in Oct (Avg Oct: 74.91/US$ against Sep: 73.56/US$) amid strong dollar index, high crude prices.
After witnessing net inflows in Aug-Sep, there was net FPI outflows in Oct (~US$1.7 bn), driven mainly by equities. October saw forex reserves increase 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, rising crude and commodity) and rose post policy in absence of no GSAP calendar announcement and expectations of robust growth (RBI has revised upwards its growth quarterly projections). Even after assurance from the RBI on lower for longer rates to support growth and revising down the inflation projections in policy meet, the 10 Yr benchmark, which was in range of 6.24-6.27% before policy, rose to 6.33% post policy and stayed elevated, only to close the month at 6.39% (July through Sep end: 6.20% - 6.22% range). Term premium (10 yr over 365 days) initially increased on no rate action but eased to average ~ 244 bps in Oct (Sep: 253 bps, Aug: 259, July: 237, June: 223, May: 229, Apr: 235) on reduced steepness of yield curve.
10 yr SDL took cues from Gsec to close month lower at 6.92% (Sep end: 6.79%, Aug end: 6.88%, July end: 6.96%). SDL primary supply was improved bit at Rs. 59,449 cr (Sep: 54,472 cr, Aug: Rs.60,650 cr). The spread between 10 yr SDL over G-sec narrowed to average 57 bps in Oct (Sep: 61 bps, Aug:71 bps). Like SDLs, AAA bonds took cues from G-sec. 10 yr AAA PSU rose post policy and closed the month at 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 stagflation, elevated crude and commodity prices, supply chain disruptions taking longer than expected to sort out, slowing Chinese economy likely to have implication on global growth as well as inflation outlook. This has already resulted in most emerging economies switching to path of normalisation, with advance economies joining sooner than expected. This along with domestic development (improving growth prospects) is likely to have implication on RBI’s monetary policy going forward. While RBI keeps assuring to remain lower for longer and recent four inflation prints coming better than expected, the sharp spike in crude prices, supply issues is expected to have implication on inflation and growth trajectory.
  • RBI has already embarked upon the path of Liquidity normalisation by increasing the amount and maturity of VRRRs (Variable Reverse Repo Rate) and higher cut-offs in recent VRRR auctions. Further in policy, RBI has clearly indicated that it wishes to bring down the daily liquidity to manageable levels and plans to target Rs. 2-3 trn levels. Overnight rates are already at reverse repo rate (trending below reverse repo post Covid-19 on the back of humungous liquidity).
  • Going forward, yield curve is likely to be supported by improving fiscal position of the government, as witnessed from their GST transfer to states without resorting to any additional borrowing (~Rs. 1.6 trn) and their commitment to adhere to the budgeted fiscal numbers. There is a marginal chance of the reduction too, if tax buoyancy remains intact.
  • That said, no GSAP calendar and OMO (Open Market Operations) twist likely only on need basis expected to have implication for liquidity and yield management dynamics
  • The current steepness in the yield curve along with the RBI policy makes the outlook constructive for most debt funds.
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