The levels of 1 year CP, and CDs and 3 to 5 year Corporate Bonds are highly attractive and present very low risk. 1 year CPs and CDs are at levels of around 7.90% to 8.15% while 3 to 5 years AAA corporate bonds are at levels of 8.25% to 8.5%. Levels of credits are over 200bps above the repo rate and are factoring in at least a 100bps rate hike with a dramatic fall in liquidity. Rate hikes are unlikely to be 100bps in the near term with even a 25bps rate hike ruled out in the June 2018 RBI policy meet.
Liquidity has fallen dramatically to almost neutral levels but RBI has enough tools to infuse liquidity into the system.
IIP (Index of Industrial Production) grew by 4.4% in March 2018 and by 4.3% for fiscal 2017-18. Growth was 4.6% in fiscal 2016-17. IIP growth in March fell from levels of 7.1% seen in February 2018. IIP growth suggests that the economy is far from any signs of overheating that could lead to sustained inflationary pressures. CPI inflation for March 2018 printed at a 5 months low of 4.28%.
Food prices have driven down levels of inflation with food inflation at 2.81% in March 2018. Normal monsoon forecast will keep food price expectations low. Rising oil prices and pass through of higher commodity prices to consumers would lead to a higher effect on inflation, but overall inflation would still be muted.
The economy will get a boost from government spending as it front loads the spending to spur economic growth prior to polls in 2019. As the economy grows, tax collections will also rise. April 2018 saw GST collections cross Rs 1 trillion, the highest since GST was introduced in July 2017. Government finances will improve on higher tax collections.
Banks have largely been the cause of spike in interest rates as they have refrained from buying government bonds given ICDR (Incremental Credit Deposit Ratio) at over 100% and given that banks are running excess SLR at 30% of NDTL, against 19.5% SLR requirements. RBI will have to step in to buy government bonds to fill the demand gap. RBI has been devolving government bond auctions on to the Primary Dealers as auction bids have been negative given low demand from banks.
The benchmark 10 year bond, the 7.17% 2028 bond, saw yields close flat at 7.73%. The benchmark 5 year bond, the 7.37% 2023 bond saw yields rise by 5 bps to close at 7.81% and the 6.68% 2031 bond saw yields fall by 2 bps at 7.95%. The long bond, the 7.06% 2046 bond saw yields close flat at levels of 7.73%.
The OIS market saw 5 year OIS yields closing 4 bps up week on week at levels of 7.10%. The one year OIS yield closed up by 3 bps at 6.64%. OIS yield curve could flatten on near term liquidity issues.
Corporate bonds saw 5 year AAA corporate bond yields rise by 12 bps at levels of 8.50% and 10 year AAA corporate bond yields rise by 6 bps at 8.49%. 5 year AAA spreads rose by 7 bps at 69 bps and 10 year AAA spreads rose by 6 bps at 76 bps.
System liquidity as measured by bids for Repo, Reverse Repo, Term Repo and Term Reverse Repo in the LAF (Liquidity Adjustment Facility) auctions of the RBI and drawdown from Standing Facility (MSF or Marginal Standing Facility) and MSS/CMB bond issuance was in surplus of Rs 71 billion as of 11h May 2018. Liquidity was in surplus of Rs 472 billion as of 4th May 2018.