India: RBI likely to remain on hold in August

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1 8-Feb Apr Aug-16 Mar-15 May-15 Jul-15 Sep-16 Nov-16 Jan-17 Mar-17 In Focus: For private circulation only India: RBI likely to remain on hold in August Price pressures in food to ease on government measures and assumption of normal monsoon (% YoY) Core CPI Inflation forecast Headline CPI Comfortable liquidity and FII inflows to cap the upside in yields (%) Y Government benchmark bond Source: Bloomberg, ICICI Bank Research August 8, 216 Niharika Tripathi Samir Tripathi Sumeet Agrawal Please see important disclaimer at the end of this report We expect RBI to remain on hold in August amid increased price pressures recently. However, a 25 bps rate cut in this fiscal cannot be ruled out. Liquidity is expected to continue to remain in surplus in August and then slip into deficit in September (on the back of advance tax outflows and FCNR (B) payout). However, any stress on liquidity is expected to be mitigated via RBI s OMO intervention. We expect the 1Y Indian Government bond to trade in the range of 7.1%-7.2% by September end. Comfortable liquidity and FII inflows will cap the upside. RBI likely to remain on hold in August Reserve Bank of India (RBI) is expected to maintain status quo in its policy decision in August after reducing repo rate by 15 bps since the start of 215. With CPI inflation having risen in recent months to 5.8% YoY (particularly driven by food inflation), the likelihood of a rate move in this meet is slim. This meet will mark the last policy of RBI Governor Rajan s term. Further easing cannot be ruled out this fiscal Any room for further easing will be strictly data contingent and will warrant close monitoring of the inflation dynamics. However, we continue to believe it is premature to rule out additional easing this fiscal and a 25 bps cut is still on the cards. Inflation expected to ease: Government measures are expected to help ease price pressures in key components such as cereals and pulses. Kharif sowing has picked up on the back of upbeat monsoon and is likely to help prices cool off. While pockets of concern (vegetables and cotton) will continue to be monitored. Limited impact of 7th Pay Panel awards: Given that the Cabinet hasn t approved the hike in allowances (including HRA), the direct impact on inflation remains muted. We currently expect inflation at 5.3% YoY by March 217. Change in RBI Governor: A key parameter to watch out for will be the appointment of the RBI Governor and the stance that the new Governor takes. Formation of MPC: The composition and stance of members of the Monetary Policy Committee (MPC) will be closely tracked 1. Systemic liquidity moved into surplus in July Liquidity has improved significantly from INR 2.2 tn deficit at the start of the fiscal to an average surplus of ~INR 1 bn in July. Steep drawdown in government balances (~INR 1.8 tn) and RBI s OMO purchases (~ INR 8 bn) have been the key drivers. Going ahead, we expect the system to record surplus liquidity in August and slip into deficit in September (on advance tax outflow). Further, FCNR (B) payout will be seen in September; however any stress on liquidity is expected to be mitigated via RBI s OMO intervention (which is likely to see a step up in September). Comfortable liquidity and FII flows to cap the upside in yields The yield on the 1Y benchmark bond has slipped ~3 bps over July, in the aftermath of the Brexit and amid rising global growth concerns. In the near term, we expect the 1Y yield to trade in the range of 7.1%-7.2% by September end. Comfortable liquidity and increased FII inflow will continue to support and limit the upside. However, inflation trajectory continues to pose a risk to our view and will be closely monitored.

2 Mar-15 May-15 Jul-15 Sep-16 Nov-16 Jan-17 Mar-17 Jun-12 Dec-12 Jun-13 Dec-13 Jun-1 Dec-1 Jun-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Oct-15 Feb-16 Apr-16 Food inflation remained key in driving up inflation in recent months (% YoY) India CPI inflation CPI CPI core Food and Beverages Source: MOSPI, ICICI Bank Research Pulses and cereals inflation likely to cool on government measures Inflation to be closely watched Key concern areas in food inflation: Pulses inflation has risen sharply to 3% YoY at the start of 216 from 9.% YoY at the start of 215. However, pulses inflation has started to show slight correction on a year-on-year basis in recent months. Vegetables inflation moved into double digits at 1.7% YoY in June from 5% YoY two months back. This metric is expected to see some cooling as monsoon progresses and post Diwali once fresh produce hits the markets. Sugar inflation has risen on low produce due to water scarcity in key sugar producing states. Good monsoon is likely to aid this segment. Cereals inflation has increased over the last four months to 3.1% YoY in June from 2.2% YoY at the start of 216. An important development has been the fall in core inflation to.5% YoY in June from.9% YoY previously. Monsoon has advanced significantly and aided reservoir water levels as well as production India CPI inflation Cereals Pulses (RHS) (% YoY) (% YoY) Seasonal Rainfall (in mm) from June 1 to August 7, 216 Region Actual Normal % Departure from Long Period Average All India % East & Northeast India % Northwest India % Central India % South Peninsula % Kharif sowing has picked up on monsoon and government steps (including MSP hikes) Source: IMD, ICICI Bank Research On the assumption of normal monsoon and easing price pressures in food, we expect CPI at 5.3% YoY in Mar-217 (lakh hectare) Area sown in Area sown in Change (% YoY) Rice Pulses Coarse Cereals Oilseeds Sugarcane Jute & Mesta Cotton Total (% YoY) Core CPI Headline CPI Forecasts Source: PIB, ICICI Bank Research 1 MPC decisions will be on a majority vote with the RBI Governor holding a casting vote. The Governor does not have a veto vote. 2

3 Jul Apr Apr-16 2-Apr Apr Aug-16 Aug-15 Oct-15 Feb-16 Apr-16 Systemic liquidity has improved drastically post RBI s change in liquidity stance in April Systemic liquidity moved into surplus in July Government balance with RBI has seen a sharp drawdown (liquidity positive) Systemic Liquidity Surplus Deficit 2, 1,5 1, 5-5 Government balances with RBI Source: RBI, ICICI Bank Research Currency in circulation (CIC) had shown slight correction recently; however continues to remain elevated (INR tn) Currency in Circulation (CIC) Growth (RHS) (%YoY) (INR tn) Fiscal year analysis Outstanding CIC Start End Change FY217 (YTD) FY FY FY217 monthly analysis Outstanding CIC (INR tn) Start End Change July June May April Liquidity to remain comfortable in August; likely to slip into deficit in September Systemic liquidity Aug-16 Sep-16 Opening systemic liquidity Core balance Govt balance Drivers of Liquidity Rise in Govt balance Increase in currency in circulation Increase in bank reserves OMO intervention(purchase) 3 FX intervention (BoP) FX maturity 13 FCNR (B) payout -22 Closing balance Closing systemic liquidity (292) Core balance Estimated closing govt. balance ,8 Source: RBI, ICICI Bank Research Liquidity forecast: Systemic liquidity improved from surplus of ~INR 6 bn levels as of end-june 216 to a surplus of ~INR 29 bn by end-july 216 and is expected to improve to ~INR 25 bn- INR 3 bn by end-august 216. This is largely on the back of rise in government spending, slight fall in currency in circulation and some FX intervention. Thereafter, systemic liquidity is likely to move into a deficit of ~INR 2 bn- INR 3 bn by September end post advance tax outflows. RBI dividend of ~INR 7 bn has been budgeted, and in line with previous years, has been captured within the month of August. Current projections suggest muted OMO purchases by RBI in August, given the projected improvement in liquidity. However, OMO purchases worth INR 3 bn have been assumed in September. FCNR (B) payout will be seen in September; however any stress on liquidity is expected to be mitigated via RBI s OMO intervention. 3

4 9d 18d 72d 1d 18d 216d 252d 288d 32d 36d 396d 32d 68d 5d 5d 68d 86d 18d 8-Feb Apr Aug-16 Indian Government bonds to trade with a bullish bias The 1Y G-Sec bond yield has fallen ~3 bps over July, in the aftermath of Brexit and as FII inflows in debt market picked up in July (%) Y Government benchmark bond US D mn Debt Equ ity Total Apr Source: Bloomberg, ICICI Bank Research Yields across all maturities have fallen (%) India benchmark yield curve July 1st Source: Reuters, ICICI Bank Research Current 1Y Indian Government bond to trade in the range of 7.1%- 7.2% by September end Supply FY217 (Forecast) Dated securities 25 Tbills 3 Net SDL issuance 31 Total 765 Demand Bond market dynamics SLR demand by banks 28 Demand from PFs & insurance companies 275 Demand from Mutual funds 15 Demand from FIIs 5 Demand from RBI 22 Demand from others (including corporates, state Governments, foreign Central Banks) 2 Total 855 Excess supply -9 Deposit growth assumed at 11% Source: Bloomberg, ICICI Bank Research Yields to remain supported with global yields on a downward trend and as investors search for yields Snapshot: sovereign bond yields (%) 2Y 5Y 1Y Switzerland (.95) (.9) (.56) Denmark (.57) (.3).6 Sweden (.67) (.1).1 Germany (.62) (.52) (.7) Finland (.6) (.7).7 Netherlands (.6) (.5).3 Austria (.55) (.6).1 France (.56) (.).15 Belgium (.59) (.6).17 Japan (.17) (.15) (.5) UK US As of Aug 8 th, 216 Source: Bloomberg, ICICI Bank Research Key domestic triggers over the next few months Source: ICICI Bank Research

5 Jul-15 Aug-15 Oct-15 Feb-16 Apr-16 APPENDIX RBI has ramped up liquidity injection via OMO purchases RBI liquidity operations Net sale Net purchase

6 ICICI Bank: ICICI Bank Towers, Bandra Kurla Complex, Mumbai- 51. Phone: (+91-22) Treasury Research Group Economics Research Sunandan Chaudhuri Senior Economist (+91-22) Kamalika Das Economist (+91-22) 8-11 (ext 628) Samir Tripathi Economist (+91-22) Niharika Tripathi Economist (+91-22) 8-11 (ext 693) Sonal Surana Economist (+91-22) 8-11 (ext 723) Radhika Wadhwa Economist (+91-22) 8-11 (ext 726) Treasury Desks Treasury Sales (+91-22) Currency Desk (+91-22) Gsec Desk (+91-22) FX Derivatives (+91-22) /3 Interest Rate Derivatives (+91-22) Commodities Desk (+91-22) Corporate Bonds (+91-22)

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