like festival holiday and disruption due to heavy rains in South India. We believe that it would get settled down in a c
Fixed Income Outlook Debt markets Government 10yr benchmark bond was trading in the range of 7.58% - 7.69% during the month as the Government announced new 10yr benchmark security during the month. However the old benchmark paper’s trading range was in 7.72% - 7.81% same as last month as there were no fresh triggers to induce any meaningful shift in the yield curve. The New benchmark security closed the month at 7.64%. In Money markets short term Bank Certificate of Deposit yields moved up sharply during the month and were trading in the range of 8.00% - 8.10%. This up move was triggered by tight liquidity in the banking system and increased issuances in short term by NBFC’s and banks in a busy quarter ending. Foreign Portfolio Investment saw outflows in equities and marginal inflows in debt during the month. Debt inflows were US$ 0.18bn as against outflows of US$ 0.63bn in the last month. Equities saw outflows of US$ 1.81 bn against the inflows of US$ 0.03 bn seen in December. Domestic Macro Factors The Index of Industrial Production (IIP) contracted by 3.2% y-o-y in November against an increase of 9.9% (revised up from 9.8% printed earlier) in October. This was the first negative print in IIP since October 2014 and also the quickest pace of contraction since October 2011. This was also well below the market expectation of a 2% growth. Part of this contraction was expected due to high base effect and festival related holidays in November. However the print was lower than expected due to sharper than expected decline in capital goods and consumer non-durable goods. In terms of use-based classification, capital goods production fell 24.4% against a growth of 16.3% in October 2015. Manufacturing output growth contracted in November by 4.4% vs a growth of 10.6% in October; mining growth also decelerated to 2.3 % from 5.2 % in October and similarly electricity growth dropped sharply to 0.7% compare to 9% in October. Industrial production data has been quite volatile in the recent past and needs to be seen in conjunction with other economic data to assess the underlying momentum. We have seen continuous improvement in Industrial production data barring the sharp decline in November which was mainly due to some one-offs like festival holiday and disruption due to heavy rains in South India. We believe that it would get settled down in a couple of months and trends in coming months needs to be watched. We expect that supported by stronger discretionary consumer demand, increased Government spending on Infrastructure and the Government’s efforts to debottleneck investment and policy reforms Industrial production will improve in coming months. India’s external trade deficit rises to USD 11.7 bn vs. $ 9.8 bn in November. Export growth continued to fall and printed at -14.7% in December against (-24.4%) yo-y in November, marking the 13th consecutive month of decline. Imports also continue to decline at (-3.9% y-o-y) in December compared to (-30.3% y-o-y) in November. The trade deficit increased in sequential terms due to broad-based rise in imports led by pearls, precious & semi-precious stones, machinery and electronic goods. Gold imports increased by US$0.3bn from the previous month to US$3.8bn in Dec. Oil imports were (-) 33.2% vs (-) 45% y-o-y in November. Non-oil non-gold imports contracted by (-3.3%) in December vs (-21.3%) in November. The moderation in contraction in non-oil non-gold imports is due to the rise in electronic goods imports. The rupee depreciated by 2.48% from last month and closed at 67.79/$. India’s forex reserves are close to at $347.56bn in the week ending January 22, 2016. Inflation Headline CPI inflation accelerated to 5.6% y-o-y in December from 5.4% in November, this was largely in line with market expectation of 5.5%. This marginal uptick in headline CPI inflation was due to higher food prices and unwinding of favourable base effect. Food inflation rose to 6.4% from 6.1% in November and core CPI (ex food & fuel) inched up to 4.5 from 4.3% in November. However Core CPI (ex food & fuel) after removing transportation Index from miscellaneous category moderated to 5% from 5.1% in November. WPI inflation fell by 0.7% y-o-y against 1.99% fall in November, this is 14th consecutive month of decline However, the pace of decline has been moderating over the last 4 months. This fall was less than the market expectation of 1.15%.
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Food inflation jumped to 6.6% in December from 4.4% seen in November. The non-food, non-fuel index contracted by 2.6%YoY vs a decline of 3% seen in November. The non-food index fell declined 4.3% YoY in Dec-15, compared to a decline of 5.1% YoY in Nov-15. The current trend in WPI inflation suggests that the high base effect has started waning and we can see WPI turning into positive in coming one or two months. However given the global commodity prices trend we expect WPI to remain subdued. Outlook The US Federal Reserve in its January 27 monetary policy meeting didn’t surprise the market and maintained a status quo on rates. FOMC while assuring that the Fed is carefully monitoring the global economic and financial developments and its implications on inflation, labour market and balance of risk to growth outlook acknowledged that the economy has slowed into the end of last year and also moderated their comments on inflation, house spending growth and business fixed investment growth. This new tempered guidance is in line with the market expectations and suggests that the pace of rate hikes will remain muted and driven by data, as inflation still remains much weaker than the Fed’s target. In the Eurozone, European Central Bank (ECB) maintained status quo and kept the benchmark rates unchanged in its January 21 monetary policy meeting. ECB President Draghi said that Central Bank will ‘reconsider’ policy stance in its March meeting as downside risks have increased in 2016. He said that more easing could be coming within months. Global market turmoil, plunging oil prices and weaker growth across emerging markets are quickly increasing economic headwinds for Europe so the ECB will need to be ready to use any possible instrument as inflation risks turning negative and growth slows. India witnessed some currency volatility but ample forex reserves, including favourable economic fundamentals helped cushion the impact. In domestic economy, fiscal deficit management remains the main challenge along with inflation as meeting three competing objectives of simultaneously funding higher wages (7th pay commission), continuing government capex and lowering the fiscal deficit. Also the key medium-term risk is a lack of progress on reforms. There are options available such as reducing government stake across public sector enterprises and gains from food subsidy rationalization. But these will need renewed efforts by the authorities. If the government cannot do this and instead cuts back on capital expenditure or dilutes the fiscal consolidation path, hard won gains on macro stability could be compromised. In a widely expected move RBI in its monetary policy on Feb 2, decided to wait and watch for the implementation of fiscal deficit management by government both in terms of quantitative as well as qualitative in the upcoming Union budget along with emerging trends in inflation and growth. RBI also mentioned about possible challenges coming out of 7th Pay commission recommendations to fiscal deficit targets and inflation in its policy statement. We expect that apart from factors mentioned above RBI will also be watchful for factors like pass though of recent rate cuts into lending rates, developments in global macroeconomic environment, impact and pace of unwinding of easy monetary policy in USA and volatility in currency market before taking any further action on monetary policy. We believe that the present level of 10 years GSEC at 7.65% (old benchmark at 7.78%) looks attractive and Investors in long duration funds like Gilt & Income funds can remain invested for a better exit opportunity. Incremental investments can be done at these yields with investor having long term horizon as volatility emanating from global events can keep rates elevated temporarily. The case for lower long term rates is also supported by the existing spread between overnight rate and ten year G-Sec yield. This spread is currently at 100-110 bps however history shows median spreads have been around 40-50bps giving cushion to traders and investors to absorb intermittent volatility. We also recommend investors investments in short to medium duration products like Ultra Short Term fund, Income Plus and Short Term Bond funds with 3 to 9 month’s Investment horizon.
February 2016
Fixed Income Desk
Sundaram Mutual Fund
