Jan-15 Mar-15 May-15 Jul-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 3M 6M 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 10Y 11Y 12Y 13Y 14Y 15Y 19Y 24Y 30Y In Focus: India Fixed Income For private circulation only India Fixed Income: Remain constructive despite global volatility Yield curve has shifted lower over in recent months 8.3 8.1 7.8 7.7 Yield curve 1- Current In recent months, the yield curve has shifted lower. Factors like comfortable July CPI, dovish RBI guidance, fall in commodity prices and possibility of delay in Fed lift-off have provided support. However, Rupee depreciation has capped gains We believe that lower than expected July CPI print builds case for a 25 bps reduction in repo rate in September policy We maintain our view of decline in 10Y benchmark bond yield to 0-7.70% by end-dec 2015. The upside risk is from rise in global volatility which could fuel Rupee depreciation, while downside risk is from a hike in FII debt limit 7.4 Our CPI projection is 40-50 bps lower compared to RBI s glide path 5.5 5.0 4.5 4.0 3.5 3.0 CPI projection ICICI Bank Source: CEIC, ICICI Bank Research August 24, 2015 Kanika Pasricha kanika.pasricha@icicibank.com +91-26537243 Please see important disclaimer at the end of this report RBI Global economic uncertainty leading to market rout The recent developments have worried global investors. Chinese policymakers devalued Yuan by ~3.5%. Further, dovish FOMC minutes deteriorated sentiment, as they indicated risks to US economic outlook from weakness in China, Dollar strength and fall in crude prices. The ensuing global risk off triggered a sharp drop in commodity prices, global equities and FX, especially emerging markets. Yields witnessed downward pressure though Rupee fall put a floor Since early June-2015, domestic bond yields have moved down. This is attributable to factors like lower than expected July CPI print, dovish RBI guidance, fall in global commodity prices and increased expectation of a delay in Fed lift-off. However, the gains though have been capped by depreciation pressure on Rupee which has dropped to 66.43 levels, weakest since Fed taper tantrum in 2013. India, though has been relatively less affected compared to other EM peers given improvement in fundamentals over last 2 years and impact of fall in commodity prices. Meanwhile, the depreciation pressure on the Rupee has led to risk of carry unwind thereby leading to pressure on domestic Gsec. July CPI at 3.8% likely to give RBI comfort for another rate cut Post July CPI, we have revised down FY2016 CPI projection to an average 4.9% YoY, with March-2016 level of 5.4% YoY. This builds case for another 25 bps repo rate cut in September. Beyond that, further rate cuts are likely to be contingent upon RBI s adoption of medium term CPI goalposts. Fiscal situation continues to show improvement During Q1 FY2016, the Government recorded fiscal deficit of 51.6% of budgeted, narrower than 56.1% in Q1FY2015. The quality of spending has improved with a focus on capex. Further, the Finance Ministry has sought a Parliamentary approval to spend additional INR 255 bn, majorly for capital infusion into state-owned banks. This would only be partially offset from savings in fuel subsidy bill of ~INR 150-200 bn. We also remain concerned regarding weakness in capital receipts, though the INR 90 bn worth IOC disinvestment being conducted today is a step in the right direction. We remain constructive on bonds in the medium term We continue to project a fall in 10Y yield to 0-7.70% by end-dec 2015. The upside risk to our view is from rise in global volatility which could fuel depreciation pressures on Rupee. Further deterioration in monsoon remains a risk to August CPI reading due before the RBI s September policy. If Fed hikes rate in September, which is not our baseline scenario, it could also lead to rise in bond yields. The downside risk to our yield view is from a FII debt limit hike.
Feb-14 May-14 Nov-14 May-15 3M 6M 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 10Y 11Y 12Y 13Y 14Y 15Y 19Y 24Y 30Y India Fixed Income Global risk off over last month Global Market roundup Current level 1 month return Equities return 1 year return Dow Jones 16460 (6.3) (3.2) FTSE 5934 (9.8) (12.4) Nikkei 18541 (9.8) 19.3 Hong Kong 21252 (15.4) (15.4) Sensex 25742 (8.4) (2.6) Kospi 1830 (10.6) (11.0) Indonesia 4164 (14.3) (19.9) Brazil 45720 (7.2) (21.7) Russia 722 (15.9) (42.7) 10Y Bond yield (bps) US 1.96 (30.1) (44.1) UK 1.76 (17.2) (64.3) Japan 0.35 (6.3) (16.2) India 7.89 6.7 (62.4) Brazil 14.00 165.5 214.9 Indonesia 9.05 7 80.1 Currencies return DXY INDEX 94.04 (3.3) 14.2 EURUSD 1.15 4.8 (12.7) GBPUSD 1.58 1.6 (5.0) USDJPY 119.67 (3.3) 15.0 USDINR 66.65 4.1 1 USDBRL 3.56 55.5 USDIDR 14050 4.5 19.9 USDRUB 71.01 21.2 96.3 USDZAR 13.24 4.5 23.6 USDTRY 2.96 7.9 35.7 USDCNY 6.40 3.1 4.1 USDKRW 1199 2.7 1 Commodity return WTI 38.9 (19.1) (58.4) Brent 43.7 (19.9) (57.2) CRB 191.3 (6.7) (33.7) Copper 5055.0 (7.3) (27.9) Gold 1159.3 5.5 (9.2) Yield spreads has narrowed (bps) 6 45.0 3 15.0-3 Yield spread 30Y-10Y Global economic uncertainty leading to market rout The global economic situation continues to remain fragile even when we are less than a month away from the 7 th anniversary of Lehman collapse (15 th September 2008). The global policymakers utilized a mix of policy stimulus in order to combat the Global Financial and Economic crisis, which was touted to be the worst since Great Depression of 1929. However, the broad economic prospects remain weak, with major economies like Eurozone and Japan along with China relying on policy support to stimulate recovery. The last month has witnessed adverse global economic developments. Chinese policymakers devalued Yuan by ~3.5%. This exacerbated the fall in commodity prices, with WTI crude slipping below psychological USD 40/bbl mark. Further, dovish FOMC minutes deteriorated market sentiment, as they indicated the risks to US economic outlook from weakness in China, Dollar strength and fall in crude prices. The ensuing global risk off triggered a sharp drop in global equities and currencies, especially emerging markets. Meanwhile, safe haven demand for DM bonds has strengthened, though Dollar remained under pressure on possibility of delay in Fed liftoff to end- 2015. The EM pack has been divided on the basis of commodity winners and losers, with economies like Indonesia, Brazil and Russia falling in the latter category and have consequently, witnessed a sharp selloff across equity, FX and debt markets. Meanwhile, on the domestic front, India, a net importer of commodities has been relatively less affected. However, Yuan devaluation is likely to keep Rupee under pressure, as it adversely affects the external sector outlook, in terms of a rise in imports along with loss of global export competitiveness. Yields witnessed downward pressure though Rupee fall put a floor The yield curve has shifted downward in recent months on account of various factors: (1) Lower than expected July CPI reading, (2) Dovish RBI guidance, (3) Easy liquidity situation, (4) Fall in commodity prices along with (5) Expectation of delay in Fed rate hike. The yield spread has narrowed, with the 30Y-10Y spread falling possibly due to relatively strong demand at the longer end of the curve. However, the gains though have been capped by depreciation pressure on Rupee which has dropped to 66.43 levels, weakest since Fed taper tantrum in 2013. India, though has been relatively less affected compared to other EM peers given improvement in fundamentals over last 2 years and impact of fall in commodity prices. Meanwhile, the depreciation pressure on the Rupee has led to risk of carry unwind thereby leading to pressure on domestic Gsec. 8.3 8.1 7.8 7.7 7.4 Yield curve 1- Current 2
Jan-15 Mar-15 May-15 Jul-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 India Fixed Income July CPI slipped to 8-month lows July CPI at 3.8% likely to provide RBI with comfort for another rate cut Inflation reading for last month came in at 8-month low of 3.78% YoY. The reading provided a pleasant surprise and was sharply lower than expectations (ICICI: 4.2%, Consensus: 4.5%). While a favourable base effect provided support, there was a fall in sequential momentum by ~50% versus June- 2015. The fall in inflation was broad based, with both food and core CPI slipping to multi-month lows. Comparison of ICICI CPI projection with the RBI's glide path CPI projection ICICI Bank RBI Source: CEIC, ICICI Bank Research 5.5 5.0 4.5 4.0 3.5 3.0 Source: CEIC, ICICI Bank Research Quality of fiscal spending has improved Fiscal component Receipts Gross taxes (INR bn) FY2015 FY2016 1443.0 24.7 9.2 11.8 2151.1 1 13.4 14.8 States' share 1122.7 35.1 21.7 21.4 Total taxes (Net to Centre) 1016.9 2.6 10.1 11.1 Non taxes 395.2 157.6 7.2 17.8 Non-debt capital receipts 30.9 134.9 1.8 3.9 Recoveries of loans 13.9 14.7 11.5 12.9 Disinvestment 17.1-0.2 2.5 Expenditure 4310 4.2 23.0 24.2 April-June FY2016 April-June fiscal (% of budgeted) Revenue 3724 2.4 23.2 24.2 Capital 586 17.6 22.0 24.3 Fiscal deficit 286 56.1 51.6 After incorporating the latest CPI print, we are revising down CPI projection for the current fiscal to an average 4.9% YoY and March-2016 inflation to 5.4% YoY. Our projections incorporate impact of below average monsoon and stable crude at current levels. Consequently, we believe that the RBI s Jan-March 2016 CPI projection of 6.1% is likely to be undershot by 40-50 bps. This builds a case for another 25 bps repo rate cut in the September policy meeting. Beyond that, further rate cuts will be contingent upon RBI s adoption of medium term CPI goalposts (Jan-2017: 5% & Jan-2018: 4%). While the RBI has not ruled out the possibility of an inter-meeting cut, we expect the Central Bank to wait for the August CPI print due on 12 th September for confirmation of disinflation trends and also watch for the impact of recent global volatility on Indian markets along with FOMC policy action on 16-17 th September. Consequently, the RBI is expected to ease policy on scheduled meeting date i.e. 29 th September. Fiscal situation continues to show improvement During April-June FY2016, the Government has recorded a fiscal deficit of 51.6% of the budgeted levels, narrower than 56.1% during the same period in FY2015. The improved fiscal performance is attributable to a faster growth in revenue receipts (primarily tax and non-tax) while expenditure growth has been relatively muted. Gross tax revenue rising at a healthy pace: As compared to April-June FY 2015, gross tax revenues have increased by 1% for the same period during FY2016. The growth in revenues was primarily driven by indirect taxes especially excise. Non-tax revenue growth remains elevated: Receipts from non-tax revenue growth have increased sharply during April-June FY2016, registering 157.6% YoY growth. This is because proceeds from March-2015 spectrum auction which were received by the Government in the current fiscal. 3
India Fixed Income Strong tax revenue growth led by indirect taxes Tax compone nt Gross taxes 2151 1 Direct tax 1000 0.7 of which Corporate tax 521 3.2 Income tax 451-2.9 Indire ct tax 1151 37.6 of which April-June FY2016 (INR bn) Excise duties 375 104.0 Customs duties 472 22.0 Services tax 304 14.2 Subsidy bill has been muted especially for fuel Source: CGA, ICICI Bank Research Quality of spending has improved: Expenditure growth has been muted during the first quarter, at 4.2% YoY vs. a budgeted level of 8.1% YoY. However, this fiscal has seen a higher proportion of spending being attributed towards capital expenditure (significant increase of 17.6% YoY); and a smaller rise in revenue expenditure (increase of 2.4% YoY). The decline in subsidy bill to ~INR 700 bn in Q1 FY2016 as against INR 900 bn during the same period last fiscal has reduced revenue expenditure growth. In particular, fuel subsidy bill was only INR 9 bn in Q1 as against budgeted INR 300 bn for the fiscal. Disinvestment revenues continue to lag: Even though non-debt capital receipts as a ratio of budgeted estimates have seen an increase during April- June FY 2016 as compared to last year, a substantial portion of budgeted inflows under disinvestment has not been received as yet (only INR 17.1 bn for Q1 FY2016 vs. INR 695 bn budgeted for the fiscal). On balance, fiscal situation has improved since the start of FY2016. Meanwhile, the Finance Ministry has sought a Parliamentary approval to spend additional INR 255 bn, majorly for capital infusion into state-owned banks. The additional fiscal burden could be partially offset by savings in fuel subsidy bill of ~INR 100-150 bn from fall in crude prices along with implementation of Direct Benefit Transfer scheme. We also remain concerned regarding weakness in capital receipts, though the INR 90 bn worth IOC disinvestment being conducted today is a step in the right direction. Fed action to be closely watched The July FOMC guidance was broadly unchanged with the statement highlighting an improvement in economic activity during the last quarter, while subdued inflation weighed on rate hike prospects. The minutes of the meeting released last week significantly reduced odds of a September lift-off as most (participants) judged that the conditions for policy firming had not yet been achieved. However, a lift-off in 2015 remains on the cards as members noted that conditions to support normalisation were approaching. On balance, we believe that despite the improvement in macroeconomic fundamentals, subdued inflation and tepid wage growth are likely to push the lift-off to end 2015. We remain constructive on bonds in the medium term We continue to project a fall in 10Y yield to 0-7.70% by end-dec 2015. The upside risk to our view is from rise in global volatility which could fuel depreciation pressures on Rupee. Further deterioration in monsoon remains a risk to August CPI reading due before the RBI s September policy. If Fed hikes rate in September, which is not our baseline scenario, it could also lead to rise in bond yields. While OMO sales could also lead to upward pressure on bonds, the RBI has addressed such concerns by asserting that the sterilization tool would be used when borrowing calendar is light (i.e. at the end of fiscal) in order to limit market disruptions. The downside risk to our yield view is from a FII debt limit hike on conversion into Rupee terms, though the probability for the same is low in the near term given the fragile global market situation and surplus domestic liquidity. 4
Feb-14 Apr-14 Jun-14 Feb-14 Apr-14 Jun-14 Feb-14 Apr-14 Jun-14 3M 6M 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 10Y 11Y 12Y 13Y 14Y 15Y 19Y 24Y 30Y Aug-99 Aug-01 Aug-03 Aug-05 Aug-07 Aug-09 Aug-11 Aug-13 India Fixed Income Yield curve Deposit and credit growth 8.3 8.1 Yield curve 1- Current 4 35.0 3 Deposit Credit 25.0 7.8 7.7 7.4 2 15.0 1 5.0 OIS spread MIFOR spread 9.0 OIS Spread (5Y-1Y, RHS) 1Y 5Y (bps) 9.0 MIFOR Spread (5Y-1Y, RHS) 1Y 5Y (bps) -3-45.0-6 -75.0-3 -45.0-6 -75.0-9 -105.0-9 -12 10-year Gsec corpo bond spread Systemic liquidity and call rate 1 Spread (RHS) 10Y AAA corp 10Y Gsec (bps) Systemic liquidity Call rate (` bn) 400 9.5 9.0-3 -45.0 0-6 -75.0-9 -105.0-400 -800-12 5.5-1,200 Market rates Issuances Central government borrowings in FY16 (INR bn) Gross market borrowing (dated securities) - Budgeted 6008 - Completed 2140 Net market borrowing (dated securities) - Budgeted 4564 - Completed 1223 Memo items: OMO sales 193 Auction Results Notified amount (INR bn) Date of last auction Cut off in last auction Change in cut off yield (bps) Date of auction Security Cut off yield 21-7.35% GS 2024 20 7.9318 7-7.9744-4.26 21-7.88% GS 2030 60 7.9275 7-7.9791-5.16 21-7.95% GS 2032 30 249 7-625 -3.76 21-8.17% GS 2044 30 150 7-363 -2.13 5
India Fixed Income ICICI Bank: ICICI Bank Towers, Bandra Kurla Complex, Mumbai- 400 051. Phone: (+91-22) 2653-1414 Treasury Research Group Economics Research Sunandan Chaudhuri Senior Economist (+91-22) 4008-7525 sunandan.chaudhuri@icicibank.com Kamalika Das Economist (+91-22) 4008-1414 (ext 6280) kamalika.das@icicibank.com Kanika Pasricha Economist (+91-22) 4008-7243 kanika.pasricha@icicibank.com Samir Tripathi Economist (+91-22) 4008-7233 samir.tripathi@icicibank.com Tadit Kundu Economist (+91-22) 4008-1414 (ext 2087) tadit.kundu@icicibank.com Niharika Tripathi Economist (+91-22) 4008-1414 (ext 6943) niharika.tripathi@icicibank.com Nupur Samar Economist (+91-22) 4008-1414 (ext 2180) nupur.samar@icicibank.com Ankita Gupta Economist (+91-22) 4008-1414 (ext 2085) ankita.gupt@icicibank.com Treasury Desks Treasury Sales (+91-22) 2653-1076-80 Currency Desk (+91-22) 2652-3228-33 Gsec Desk (+91-22) 2653-1001-05 FX Derivatives (+91-22) 2653-8941/43 Interest Rate Derivatives (+91-22) 2653-1011-15 Commodities Desk (+91-22) 2653-1037-42 Corporate Bonds (+91-22) 2653-7242 6
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