September 2021: Emerging perspective on Normalisation of Growth, Inflation and Rates Trajectory
Delta Variant, which saw ferocious rise and spread across globe in the months of July and August 2021, saw rapid decline in most part of the world in the month of September. While this augur well with economic activities, several new headwinds are rising in form of supply bottlenecks like natural gas shortages, China factor (right from commodities, electricity, regulatory constraints to growth), rising inflation and normalisation of liquidity (scaling back of asset purchases) & rates by Central Bankers having implication on near & medium term growth prospects.
Back home, with minimal Covid cases seen in September quarter and maximum opening up (barring some services) happening in July and August, most hi-frequency indicators are back to pre-Covid levels indicating broad-based recovery led by rural demand. Pent-up demand and festive season provided boost to the domestic demand. Monsoon have been close to normal aided by higher-than-normal rains in September. (First advance estimate of kharif food grains indicates record production).
August 2021 Headline CPI print came lower at 5.3%y/y (Previous month: ~5.59%y/y). While there was favourable base effect in play, the headline print came better than consensus expectations (5.6%y/y) – indicating that the sequential momentum has come down (especially food and services). In fact, this is third consecutive month of lower than consensus print. Core inflation moderated to 5.89%y/y (Previous: 6.01%y/y) mainly on favourable base effect and lower uptick in housing and services inflation.
Globally, over last couple of months, the inflation has been showing upward pressure - driven by base effect, pick-up in economic activities, pent up demand, 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.
Globally, there is a rising trend towards normalisation of monetary policy. In backdrop of elevated inflation, US Federal Reserve Chairman indicated that US might start tapering by November 2021 and complete it by mid-2022 (earlier than expected). Further, the Dot plot suggest that rate normalisation can start as early as next year and might be higher than initial expectations (August policy). Similarly, Bank of England hinted that it might start rate hike in 2021 itself and might hike more (vis-à-vis previous policy). Many emerging economies have started normalizing rates since June 2021. September 2021 saw Brazil hiking rate further by 100 bps (second consecutive hike by similar bps)).
In India, RBI, in post policy meeting and later in various forums, had assured that output gap remains and rate normalization will be very gradual. However, the rapid improvement in hi-frequency indicators, increase in size of VRRR (Variable Reverse Repo Rate) (to suck out excess system liquidity) and its higher cut-offs, most Central bankers globally switching/planning to switch to normalisation (rates and liquidity) sooner than later is likely to have implications for India’s monetary policy.
From daily deployment of Rs. 7 trillion at the start of month, RBI, through its increasing size of VRRR auction (variable reverse repo rate), has reduced down the amount to Rs.3.5 trillion-4 trillion by September end, thereby reducing the daily availability of system liquidity indicating that RBI wants to normalise liquidity gradually and to reduce financial instability and inflation risk as the economic activities picks up. (Note that this is in stark contrast to humungous liquidity floating since start of pandemic).
April-August 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 in August (both revenue and capex), April-August expenditure growth was modest. Robust revenue growth and muted expenditure has kept fiscal deficit at record low ~31% of budgeted estimates (Normal times: 90% of Budgeted Estimates). Advance tax collection in September quarter was also robust, so was the September GST print.
India’s External Sector & Global Update
Crude witnessed sharp rally in September driven by pick up demand and shortage of natural gas factor. Starting the month at US$71/barrel, Brent breached record levels of US$78/barrel by month end. Brent crude rose by 6.5% m/m in September (average US$74.6/barrel as against 70.02/barrel in July). While first half of the month saw brent at average US$72/barrel, it was average US$76/barrel in second half on natural gas shortage factor.
In the bond markets, US treasury yields were range-bound during the month and rose post US Fed hawkish policy and likely earlier and faster tapering. The US 10 Yr Treasury bond yield closed the month at ~ 1.52% (August end: 1.3%, July end: 1.24%, June end: 1.45%, May end: 1.58% & April end: 1.65%). Dollar Index continued to appreciate albeit marginally for second consecutive month.
Back home, after depreciating in June-July, INR continued to appreciate for second consecutive month by ~1% in September to close the month at 74.13/US$ (August end: 73.15/US$).
After witnessing net outflows in July, there was robust net FPI inflows in August and September (~US$3.8 bn). September saw forex reserves decline a bit to US$639 bn by mid-month. YTD FY22 Forex reserves rose by US$63 bn.
Fixed Income Market Update
Yield Levels & Spreads:
G-sec yields eased for most part of the month on appreciating currency, robust FPI flows, range-bound US yields, lower than expected inflation print and thereby its implication on monetary policy normalisation and expectations of lower than budgeted 2H borrowing calendar. It, however, rose post US policy and especially after higher cut-offs in VRRRs, which was taken by the market as not just indicator of liquidity normalisation, but also as rate corridor normalisation signal. This was clearly reflected not just in overnight rates (higher daily fixing), but also across money market rate (higher Tbill cut-offs) as well as in bond market (higher Gsec cut-offs). Better than expected 2H gross borrowing supported the yields. The 10 Yr benchmark, which had been ~ 6.23-6.24% levels in August, eased sharply to 6.12% by September 2021, but it rose post US policy and higher VRRR cut-offs to close the month at 6.22%. Term premium (10 yr over 365 days) eased a bit to average ~ 253 bps (August: 259, July: 237, June: 223, May: 229, April: 235) on reduced steepness of yield curve.
While 10 yr SDL took cues from Gsec, yet closed month lower at 6.79% (August end: 6.88%, July end: 6.96%). SDL primary supply was bit low at Rs. 54,472 cr (August: Rs.60,650 cr). In fact, 2Q SDL supply was lower than calendar. The spread between 10 yr SDL over G-sec narrowed to 61 bps from average 71 bps in August.
Bloomberg, RBI, CEIC, Finance Ministry of India, NIMF Research
- Pick-up in economic activities, rising crude and natural gas prices, implication of China factor (regulatory, growth, etc) is likely to have implication on global growth as well as on inflation outlook. This has already resulted in most emerging economies switching to path of normalisation, with advance economies likely to pick up cues sooner than expected. This along with domestic development (improving growth prospects) is likely to have implication on RBI’s monetary policy going forward. While the recent three inflation prints have come better than expected, the recent spike in crude prices, supply issues may have implication on inflation and growth trajectory.
- RBI has already embarked upon the path of Liquidity normalisation and higher cut-offs in recent VRRR (Variable Reverse Repo Rate) auctions indicates that RBI is likely to reduce rate corridor sooner than later. Overnight rates are already at reverse repo rate (trending below reverse repo rate post Covid-19 on the back of humungous liquidity). Similarly, T-bills and Gsec auction cut-offs have also come higher.
- Improved fiscal position of government (Centre & states) have resulted in lower gross borrowings, thereby reducing the fiscal drag. Fiscal deficit of Centre is likely to come lower than Budgeted.
- The current steepness in the yield curve along with the RBI policy makes the outlook constructive for most debt funds.
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