Fourth Bi-monthly policy October 2019 Highlights

Dovish view with inclination towards further rate cuts going forward.

Key Points

  • Policy repo rate reduced by 25 bps to 5.15%, reverse repo at 4.90% and MSF at 5.40%
  • Monetary Policy stance remains “Accommodative – As long as it is necessary to revive growth, while ensuring that inflation remains within target”.
  • CPI inflation projected at 3.4% for Q2:FY20 and 3.5-3.7% for H2:FY20, with risks evenly balanced.
  • GDP growth forecast reduced to 6.1% from 6.9% in FY 19-20, and in the range of 6.6-7.2% for H2:2019-20 with risks evenly balanced.
  • Liquidity to be Neutral-Positive.

Inflation

Retail inflation remained in a narrow range of 3.1-3.2% between June & August, driven by food inflation, even as fuel inflation and CPI inflation excluding food & fuel moderated.

Factors shaping inflation path- 

  • With above average monsoon, Kharif production is estimated at close to last year’s level, auguring well for the overall food supply situation.
  • RBIs forward looking survey point to weak demand conditions, with indications of softening of output prices in Q3:2019-20.
  • Geo-political uncertainties affecting oil prices may provide upside risks to the inflation outlook.
  • Three months and one year ahead inflation expectations of households polled by the Reserve Bank have risen
  • Currency depreciations in several emerging economies.

Liquidity

  • Liquidity in the system was in surplus in August-September 2019 despite expansion of currency in circulation and forex operations by the RBI draining liquidity from the system.
  • Reflecting easy liquidity conditions, the weighted average call rate (WACR) traded below the policy repo rate (on an average) by 8 bps in August and by 6 bps in September.

Current Account Deficit and Forex

  • Trade deficit narrowed during July-August 2019. Higher net services receipts and private transfer receipts helped contain the current account deficit to 2% of GDP in Q1:2019-20.
  • On the financing side, net foreign direct investment rose to US$ 17.7 billion in April-July 2019 from US$ 11.4 billion a year ago.
  • India’s foreign exchange reserves were at US$ 434.6 billion on October 1, 2019 – an increase of US$ 21.7 billion over end-March 2019.

Domestic Growth outlook cut to 6.1%

  • Growth in GDP slumped to 5% in Q1:2019-20, extending a sequential deceleration to the 5th consecutive quarter.
  • Real GDP growth for 2019-20 is revised downwards from 6.9% in the August policy to 6.1% – in the range of 5.3% in Q2:2019-20 and in the range of 6.6-7.2% for H2:2019-20 with risks evenly balanced.

Factors that will influence growth

  • Various high frequency indicators suggest that domestic demand conditions have remained weak.
  • The business expectations index of the Reserve Bank’s industrial outlook survey shows muted expansion in demand conditions in Q3.
  • Export prospects have been impacted by slowing global growth and continuing trade tensions.
  • Impact of monetary policy easing since February 2019 is gradually expected to feed into the real economy and boost demand.
  • Several measures announced by the Government over the last two months are expected to revive sentiment and spur domestic demand, especially private consumption.

Assessment of Global Growth

  • Global economic activity has slowed down since the meeting of the MPC in August 2019, amidst elevated trade tensions and geo-political uncertainty. The Institute for Supply Management’s index for September indicates that manufacturing slipped further into contraction to touch its lowest reading in a decade
  • Economic activity remained weak in major emerging market economies, pulled down mainly by a deteriorating global environment in Q3.
  • Crude oil prices were pulled down by softer demand, amidst adequate supplies in early August. Prices remained range bound until mid-September when supply disruptions on account of an escalating geo-political conflict resulted in a spike which has abated faster than expected
  • Gold prices remained elevated on safe haven demand.
  • Central banks became more accommodative with inflation remaining below targets across major AEs and EMEs

MPC voted 5-1 in favour of cutting Repo rate by 25 bps, while 1 member (Dr. Ravindra Dholakia) voted to reduce the policy repo rate by 40 bps.

Other Key Announcement

  • RBI Increase the household income limit for borrowers of NBFC-MFIs from the current level of Rs. 1 lakh for rural areas and INR 1.60 lakh for urban/semi urban areas to INR 1.25 lakh and INR 2.00 lakh, respectively. Raise the lending limit from INR 1.00 lakh to INR 1.25 lakh per eligible borrower.
  • Reserve bank have allowed banks to freely offer foreign exchange prices to non-residents at all times, out of their Indian books. Also, rupee derivatives (with settlement in foreign currency) to be traded in International Financial Services Centres.

Debt Market View

  • RBI reduced policy rate by 25 basis points from 5.40% to 5.15% and maintained its stance at “Accommodative” in order to strengthen domestic growth impulses by spurring private investment which has remained sluggish.
  • Growth is faltering, Inflation is comfortably below the RBIs target, Brent crude prices are in a comfortable zone and Liquidity continues to be in surplus zone.
  • Global central banks are increasing moving towards dovish stance.
  • With tax forgone because of Corporate tax cut, Fiscal deficit target remains a challenge. Lower GST and Direct tax collections also pose threat in achieving Fiscal target
  • High Real-rates continue to make debt an attractive asset class
  • We suggest products having maturity close to investment horizon having highest credit quality and lowest expense for investors having less than 1-year time horizon.
  • For a 3-year investor, we recommend allocation in 1-5-year average maturity segment with high credit quality portfolios mainly focused on accrual. The high-quality PSU and corporate bond spread over G-Sec is attractive
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Bond Market Update July 2019

Benchmark 10 Year G-sec bond Yield closed at 6.41% yesterday, falling by 100 bps from the high of 7.4% just two months back. It touched low of 6.25% last week. The yields had scaled a peak of 8.18% on 11 Sept’18. Thereafter, there has been a sustained decline in yields till present with yields falling to an almost 30 months low on 16 July’19. Yields are just 23 bps away from breaching the decadal post demonetization low of 6.18%. On a 15-year period, yields touched 5.24% post the Great Financial Crisis.

What is driving yields lower?

The fall in yields in the recent 2-3 months can be mainly attributed to the following reasons:

  • 3 repo rate cuts undertaken by the RBI and expectations of a further rate cut in August’19.
  • Benign retail inflation and economic growth concerns which supports further rate cuts by RBI.
  • Easing banking system liquidity – The banking system liquidity has significantly eased during June-July’19. In the month of June and July’19, the banking system liquidity has witnessed liquidity surplus for a sustained period.
    • When the banking system liquidity was pressured during FY19, the RBI constantly infused liquidity almost aggregating Rs 3 lakh Crs. into the banking system via OMO purchases.
    • In the first quarter of FY20, Rs. 52,535 Crs. have been infused into the banking system by OMO purchase.
    • Also, RBI infused liquidity aggregating Rs 69,435 Crs. during March-April’19 by undertaking 2 long term rupee dollar swap
  • Announcements in the Union Budget on gross market borrowings and fiscal deficit –
    • Government has lowered the fiscal deficit to GDP ratio to 3.3% of GDP for FY20, 0.1% lower than the ratio budgeted in the Interim Budget.
    • In addition, the gross market borrowings programme of the central government was kept unchanged at Rs. 7.1 lakh Crs. However, the important point to note is 10% of the gross market borrowing i.e almost Rs 70,000 Crs will be by issuance of sovereign bonds by tapping overseas markets which will further reduce domestic supply.
  • Indirect impact of accommodative monetary policy stance by global central banks –
    • On account of concerns surrounding global growth, major central bank across the globe have shifted their stance to a relatively accommodative monetary policy and also plans to cut policy rates to reinvigorate domestic growth.
    • With central banks of advanced economies namely US Fed, ECB, BoE planning to lower interest rates or provide liquidity stimulus have driven treasury yields across countries lower and have indirectly made Indian government securities (G-Sec) an attractive investment alternative.

Conclusion,

  • G-sec Yields have cooled off owing to multiple favourable factors at play.
  • However, the corresponding decrease in Corporate Bonds spreads has not played out yet. This is likely to get better with Corporate spreads cooling off in the near-term.
  • The reduction in Corporate spreads will reduce the borrowing cost of corporates and aid in reviving corporate profitability. This could be the next trigger for the bull equity markets.

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