The release of IIP data along with ECB easing policy aggressively further places pressure on RBI to cut the Repo rate sooner than later. Rate cut expectations shot up after the government stuck to its fiscal deficit target of 3.5% of GDP in its budget for fiscal 2016-17.
IIP (Index of Industrial Production) data released for January 2016 showed that the index fell 1.5% year on year, the third consecutive month of decline. Manufacturing index fell 2.8%, again the third consecutive month of decline. Weakness in industrial production and manufacturing is corroborated by the negative growth in exports for this fiscal year and the high output gap that was highlighted in the Economic Survey for 2015-16. Growth outlook is dim going by weakness on domestic and global demand.
ECB cut rates to zero percent and increased the size of its QE in its policy meet last week. ECB policy actions could well turn to strong capital flows into India on the back of markets searching for yields.
The CPI inflation data for February will be released on Monday the 14th of March 2016. Inflation printed at 5.69% for January 2016. RBI is confident of achieving its inflation target of 5% in March 2017 given weakness in demand.
RBI could well cut rates by 25bps this week and then use its first Bi Monthly policy for fiscal 2016-17 scheduled for 5th April 2016 to set its guidance on growth and inflation.
Government bond markets saw yields closing mixed last week. The 7.72% 2025 bond saw yields falling by 1bps to close at 7.79% levels while the new benchmark ten year bond, the 7.59% 2026 bond saw yields closing flat at 7.63% levels. The 8.27% 2020 bond saw yields rising by 6bps to close at 7.71% levels. The 7.88% 2030 bond saw yields falling by 1bps to close at 8.0% levels while the 8.13% 2045 bond saw yields rising by 1bps to close at 8.20% levels.
Government bond yields will stay down on hopes of rate cuts.
OIS market saw one year and five year OIS yields rise by 4bps each week on week to close at 6.95% and 6.80% respectively. OIS yields rose as markets took profits on post budget rally and will stay down on rate cut hopes.
Benchmark AAA three year corporate bond yields fell last week on easing liquidity expectations in April. Three year bond yields fell 5bps to close at 8.18% levels with spreads down by 11bps at 40bps levels. Five year bond yields were flat at 8.45% with spreads down by 6bps at 59bps levels while ten year bond yields were flat at 8.56% with spreads flat at 78bps levels. Corporate bond yield curve will fall as market searches for yields amidst accommodative monetary policy.
Liquidity conditions are tight with 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) in deficit of Rs 1391 billion as of 11th March. The deficit was Rs 1430 billion in the week previous to last. Government surplus was at levels of Rs 949 billion last week, higher by Rs 450 billion week on week. Liquidity deficit will rise on advance tax payout next week.