Macro numbers are strong
India’s fiscal deficit was at 18 year lows for the April-August 2021 period while current account came in surplus and external debt ratios improved for the 1st quarter of fiscal 2021-22. Given such good macro data, markets will start to welcome reversal of ultra-loose monetary policy and may in fact react positively to rate hikes.
The conditions are perfect for RBI to hike rates. The Fed has indicated scaling down of asset purchases and rate hikes earlier than expected, indicating its strength in US economy. India’s fiscal position is strong and government may not need any support to its borrowing program. Given good external position and strong fx reserves at record highs, the INR is looking inherently strong.
Equity markets are at record highs and corporates are incrementally repaying debt from free cash flows. The need for support to corporate borrowing is also low.
CPI inflation is around 5.8%, core CPI, and with lack of transport, the cost of goods are rising fast. This could lead to high inflation, though temporarily but markets may fear the high inflation. Hence RBI hiking rates as a preventive measure to show its intent to contain inflation will be welcomed by markets.
RBI policy meet this week will gain significance given the above facts.
RBI’s fine tuning of excess liquidity
In current scenario of corona pandemic, RBI is supporting economic growth with ultra-low monetary policy. In addition, RBI is adopting tools like G-SAP to infuse liquidity. There is excess systemic liquidity, which is one of the causes of rise in inflation. As per published last MPC details, inappropriate systemic liquidity was discussed during MPC meeting. It can be noted that US Fed has also signalled slashing asset purchase program considering current economic scenario.
To suck excess liquidity, RBI has been conducting fine tuning variable reverse repo operation since 1st Sep 2021. As a consequent, systemic liquidity came down to Rs 8.3 trillion as of 30th Sep 2021 from Rs 8.32 trillion as of 31st August 2021. Variable reverse repo under fine tuning operation stood at Rs 1.97 trillion on 30th Sep 2021.
Spike in short term paper yield
Short-end yield curve has steepened significantly during this week against previous week. During T-bill auction, 364 days T-bill cut-off rose to 3.81% from 3.59% in the previous week.
External Debt
India’s external debt to GDP ratio declined to 20.2% at end-June 2021 from 21.1% at end-March 2021. In absolute term, it stood at USD 571.3 billion.
Current Account Surplus
India’s current account balance recorded a surplus of US$ 6.5 billion (0.9% of GDP) in Q1:2021-22 as against a deficit of US$ 8.1 billion (1.0% of GDP) in Q4:2020-21 and a surplus of US$ 19.1 billion (3.7% of GDP) a year ago [i.e. Q1:2020-21].
Forex Reserve
India’s forex reserve stood at USD 638.64 billion as of 24th Sep 2021.
State Borrowing Calendar
As per RBI notification, states will borrow Rs 2019.87 billion during Q3FY22.
Government bonds, SDL and OIS yield movements
During last week, 6.10% 2031 yield rose by 6 bps to 6.24% while 5.85% 2030 yield increased by 2 bps to 6.20%. 5-year benchmark bond, 5.63% 2026 yield rose by 4 bps to 5.69%. 6.64% 2035 yield gained 6 bps to 6.75%. 6.57% 2033 yield rose by 5 bps to 6.62%. Long-term paper, 7.16% 2050 yield gained 8 bps to 6.94%
The spread of 10-year bond over 5-year bond rose to 55 bps from 53 bps in previous week. The 15-year benchmark over 10-year benchmark spread declined by 1 bps to 38 bps, while 30-year benchmark over 10-year benchmark spread stood unchanged at 71 bps on weekly basis.
Average 10-year SDL auction cut-off rose to 6.84% from 6.80% in previous week while spread declined to 61 bps from 68 bps (on 28th Sep, 10-year benchmark yield stood at 6.23%) in previous week.
On weekly basis, 1-year OIS yield rose by 9 bps 4.01% while 5-year OIS yield increased by 9 bps to 5.33%.
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