RBI, against all expectations kept rates status quo in its policy meet on the 6th and 7th of December. The MPC (Monetary Policy Committee) unanimously voted to hold the Repo Rate at 6.25%. RBI while acknowledging slowdown in the economy and fall in inflation due to demonetization, chose to look ahead on the effects of Fed rate hike and proposed Trump fiscal stimulus and their effects of global markets and also the stickiness of core inflation in India.
India’s IIP for October 2016 printed at negative 1.9% year on year from a positive growth of 0.7% seen in September. IIP growth for November is expected to be sharply down on demonetization effect. October number was affected by Diwali holidays as last year Diwali was in November. Inflation too is expected to print lower for November given fall in food inflation.
RBI ‘s next policy is in February 2017 post the Union Budget 2017-18. The government is likely to show high spending next year given that it would have received good revenues from declaration of black money due to demonetization. Government will also cut taxes to give confidence to consumers and businesses. Fiscal deficit will be as targeted at 3.3% of GDP. Government spending could boost growth and could also lead to higher inflation expectations.
The ECB too is paring its bond buying from April while the Fed would have guided for more rate hikes. Given domestic spending, Fed hiking rates, ECB tapering policy and governments including the US providing fiscal boost to economies, RBI could be hard pressed to lower rates in its forthcoming policies.
Bond markets will be in a wait and watch mode over the next two months and the yield curve is unlikely to shift down in the coming weeks.
The ten year benchmark bond, the 6.97% 2026 bond saw yields rise by 20bps week on week to close at levels of 6.44%. The old ten year benchmark bond, the 7.59% 2026 bond saw yields rise by 21bps to close at 6.58% levels while the 7.88% 2030 bond and the 8.13% 2045 bond saw yields rise by 29bps and 21bps respectively to close at levels of 6.80% and 6.88%. Gsec yields will rise further on Fed rate hikes.
OIS market saw one year OIS yields close up by 20bps and five year OIS yields close up by 15bps week on week. One year OIS yield closed at 6.20% while five year OIS yield closed at 6.24%. OIS yield curve will rise this week on Fed rate hikes.
Credit spreads closed up last week. Three-year benchmark AAA corporate bond yields rose by 30bps week on week to close at 7.03% levels. Credit spreads rose by 9 bps to close at 71bps levels. Five-year benchmark AAA bond yields rose by 37bps to close at 7.18% with spreads rising by 18bps at 68bps levels. Ten-year benchmark AAA bond yields rose by 27bps to close at 7.33% levels with spreads up by 7bps at 79bps. Credit spreads are likely to go down as corporate bonds turn sticky at higher levels of yields.
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) was in surplus of Rs 1184 billion as of 2nd December. The surplus was Rs 2066 billion in the week previous to last. MSS bonds outstanding were Rs 3469 billion. Government surplus was Rs 1197 billion last week .