The incoming economic data would normally have had the markets clamoring for monetary easing by the RBI. However, given that the RBI has formally adopted an inflation target of 6% for the CPI (Consumer Price Index), markets are not expecting the RBI to lower the benchmark policy rate, the Repo rate that is at 8% as of March 2014.
The markets would expect the RBI to focus on providing liquidity to the system to encourage economic growth without compromising on inflation management. The system is negative on liquidity and has been negative on liquidity for more than 3 years in running. Credit growth has come off from over 20% levels to below 15% levels over the last three years as a slowing economy coupled with rising bad loans have made banks reluctant lenders.
Dr. Raghuram Rajan the RBI Governor will have to ensure that liquidity is available in the system for economic growth to pick up. Dr. Rajan is not a big fan of bond purchases as it is seen, as back door deficit financing that is inflationary in nature. He would resort to other measures of liquidity management including CRR (Cash Reserve Ratio) cuts and term repos.
Fiscal 2014-15 would see the RBI improving the liquidity in the system and that would mean overnight money market rates moving in a Reverse Repo to Repo band of 7% to 8% rather than the Repo to MSF (Marginal Standing Facility) band of 8% to 9%, where its moving currently. The fall in overnight money market rates would help steepen the yield curve, with yields at the short end of the cure coming off.
Markets would do well to load up on bonds at the short end of the yield curve, as the curve is flat to inverted at present. FIIs have been active buyers at the short end with bond purchases of over USD 6 billion in the first three months of calendar year 2014.
India’s consumer price inflation fell to 25 months low of 8.1% in February 2014 while core inflation stripped of food and fuel prices fell to 8% levels from 8.2% levels seen in January. Wholesale price inflation fell to nine months low of 4.68%. Trade deficit fell by 42% year on year and current account deficit is expected at below USD 40 billion in fiscal 2013-14, down 54% from USD 87 billion seen in fiscal 2012-13. GDP growth for the third quarter of 2013-14 was at 4.7% levels and growth is unlikely to meet estimates of 4.9% for full year 2013-14.
Industrial production grew by 0.1% for the month of January and has shown zero percent growth for the April-January 2014 period. Manufacturing growth was -0.7% in January and -0.4% for the April-January 2014 period.
Government bond yields fell marginally last week on the back of lower inflation numbers. The benchmark five and ten year bonds, the 7.28% 2019 and 8.83% 2023 bonds saw yields fall by 5bps and 2bps to close at levels of 8.91% and 8.79% respectively. Bond markets would wait for the borrowing calendar for first half of fiscal 2014-15 that is to be released by the end of March and the RBI policy to be held on 2nd April 2014 before taking any directional bets on bond yields.
Liquidity as measured by bids for repo in the auction of the RBI, MSF (Marginal Standing Facility) borrowing and term repo borrowing totaled Rs 1120 billion last week Liquidity will get tighter on the backs of 15th March advance tax outflows and fiscal year end demand for funds. RBI conducted a term repo auction for Rs 500 billion last week while the government has announced a buyback of Rs 150 billion of bonds on the 18th of March to ease liquidity pressures.
Five and ten year benchmark AAA corporate bond yields fell by 7bps and 5bps respectively week on week on the back of FII bond purchases. Five and ten year credit spreads fell by 2bps and 1bps to close at 57bps and 69bps respectively. Corporate bond yields are likely to trend down on markets positioning for easing liquidity in April 2013.
OIS (Overnight Index Swaps) market saw the curve shift down on the back of easing liquidity expectations in April. One year OIS yield fell 5bps while five year OIS yield fell 7bps to close at levels of 8.65% and 8.47% respectively and the five over one OIS spread inverted by 2bps to close at 18 bps levels. OIS yield curve is likely to flatten on the back of better liquidity conditions going forward.