Incremental news and data point to more monetary easing by the RBI in its October 2017 policy review. RBI cut the Repo Rate by 25bps in its policy review on the 1st and 2nd of August 2017 but that is not seen as enough given weak economic data. US CPI inflation printing at 0.1% growth month on month in July (1.7% annual) against expectations of 0.2% growth, drove down 10 year US treasury yields to 2.19%, lowest in the last few weeks. US Fed had sounded uncertainty on inflation in the economy in its meet in July and that will also play a factor in RBI’s rate decision.
IIP data for June 2017 saw industrial and manufacturing growth slipping into negative territory. Industrial growth has been hit by after effects of demontization and by GST implementation in July. India’s largest lender, SBI, reported drop in profits and worsening of asset quality in its 1st quarter 2017-18 results. Large lenders including ICICI Bank, which is the largest private sector lender, have reported weak asset quality implying that stressed sectors of the economy are yet to see uptick in activity.
Government finances would also be hit by the 53.6% shortfall in RBI dividend to the government. RBI is paying the government Rs 330.1 billion as dividend for the year 2016-17, down from Rs 658.76 billion paid out last year and the lowest since 2012-13. RBI will look to lower the cost of sterilization by lowering the repo rate.
Economic survey 2016-17, Vol 2 released on the 11th of August 2017, point to worries on the economy achieving targeted growth levels of 7.5% for fiscal 2017-18. Lack of private sector investments, agricultural sector distress leading to farm loan waivers and stressed assets of banks are all contributing to lack of strong pick up in economic activity. The survey calls for more easing by the RBI.
CPI inflation for July is to be released on Monday the 14th of August and markets will watch for any weakness in core inflation, which is at around 4% levels. Headline CPI inflation was at 1.54% in June 2017 and give waning base effect, inflation could edge higher.
Government bond yields rose last week on the back of worries over US-North Korea verbal exchanges. The new benchmark 10 year bond, the 6.79% 2027 bond saw yields close up by 6bps week on week at levels of 6.50%. The old 10 year benchmark bond, the 6.97% 2026 bond, saw yields close up by 6bps at 6.70% levels while the on the run bond, the 6.79% 2029 bond saw yields close up by 6bps to close at 6.79%. The long bond, the 7.06% 2046 bond saw yields close up by 5bps at levels of 7.07%. Gsec yields will fall on rate cut expectations though yields could be pressured in the near term on global risk aversion.
The OIS market saw 5 year OIS yields rising by 6bps week on week to close at levels of 6.18%. The one year OIS yield rose by 3bps to close at 6.16%. OIS yields will fall on rate cut expectations and on fall in US treasury yields.
Corporate bond yields closed up last week. 10 year benchmark AAA bond yields closed up by 6bps at 7.33% levels with spreads flat at 73bps levels. 3 year AAA spreads were lower by 2bps at 48bps and 5 year spreads were lower by 3bps at 51bps. Benchmark 3 year AAA corporate bond yields closed up by 2bps at 6.97% levels. 5 year benchmark AAA bond yields closed up by 3bps at 7.10%. Credit spreads are likely to come off on liquidity and rate cuts.
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 Facilities (MSF or Marginal Standing Facility and Export Credit Refinance) and MSS bond issuance was in surplus of Rs 4596 billion as of 11th August 2017. The surplus was Rs 5112 billion in the week previous to last. Liquidity will stay easy on government spending and RBI fx purchases.