June 2010

Robust IIP numbers, better than expected broadband auction revenue and advance tax payments, tight liquidity conditions, rising inflation and hike in key policy rates before RBI’s policy meeting were the key highlights of the month.

The Indian economy continued to grow strength to strength. Industrial production started this fiscal year with an impressive growth of 17.6% as against 13.5% in Mar’10, primarily driven by Manufacturing and low base (Apr’09: 1.2%). Within manufacturing, the growth was pushed by Capital Goods and Consumer Durable goods. In fact, the Capital Goods sector has shown a consistent growth over last couple of months indicating higher investment. Industrial growth in recent months indicates strong investment and consumption demand. Further, the corporates expects to garner impressive profits in FY2010-11. This is reflected in impressive advance tax payment numbers

No wonder, demand for credit is on rise. After having declined to below 10% levels in Oct’09, the credit growth has picked up to 17% by Mar’10 and has further grown to 19.5% by June 18, 2010. Although April-September period is generally considered to be dull period for credit offtake, the sequential credit in current fiscal year has shown good improvement, following the domestic demand, uptick in IIP and telecom auctions.
While the economy is growing robustly, inflation continues to be a major concern. WPI-based inflation has been in double-digit since Feb’10. Inflation rose to 10.16% in May as against 9.59% in April’10 - driven mainly by primary articles, electricity, textiles, chemicals and basic metals. Almost all sub-groups within manufacturing (other than food) showed uptrend indicating the underlying price pressure. We expect inflation to remain sticky around current levels for next couple of months. Similarly, the consumer price index inflation for industrial workers (CPI-IW) continued to remain in double-digit for eleven consecutive months. Although it has depicted declining trend since Feb’10 and has come down from high of 16.22% in January 2010 to 13.33% in April 2010, it has shown pick-up in price-levels and is now at 13.91% in May’10. Not surprisingly, RBI had to step in and raised the key policy rates weeks before the scheduled policy meeting. RBI raised the repo and reverse repo rate by 25 bps each to 5.50% and 4% respectively to contain inflation and to anchor inflationary expectations as well as a part of the calibrated exit from the expansionary monetary policy,

On fiscal front, the month saw better than expected revenue generation through advance tax payments and broadband auction. Corporate advance tax outflows were around Rs. 27,000 cr- reflecting robust growth of 31%, which is fastest since 2005. Like 3G, the broadband auction fetch higher than the budgeted revenues of around Rs. 40,000 cr.

Despite the robust performance on economic front, the Indian rupee continue to exhibit the declining trend vis-à-vis American dollar since May’10 on the rising concerns about the European sovereign debt default risk and strong USD. After witnessing the appreciation in Mar’10 and Apr’10, the INR weakened by 3% in May’10 and by 1.65% in Jun’10 and stood on an average at around 46.56/USD.
G-Sec market started the month on positive note despite the tight liquidity and upward shift in yield curve witnessed towards May end on account of huge 3G auction outflows. The yields however, harden from second week onwards on the back of better than expected IIP growth and higher monthly inflation numbers and higher than expected G-Sec cut-off yields. Tight liquidity conditions on the back of advance tax and broadband auctions outflows vis-à-vis large scheduled G-Sec auction resulted in RBI announcing to conduct OMO buy-back auction worth Rs. 20,000 cr. This helped in soothing the market sentiments. 10 year benchmark closed the month at 7.55% (previous month’s close: 7.56%).
Corporate bond yields remained range-bound during the month. 10 year AAA declined to 8.69% by month end from 8.70% in the previous month, while 5 year AAA increased to 8.23% from 8.19% in the previous month. Tight liquidity conditions due to advance tax outflows and huge 3G and broadband auction resulted in lower trading volumes in the corporate bond market in Jun’10. Volumes declined to Rs. 54,404 cr in Jun’10 vis-à-vis Rs. 72,711 cr in May’10. FII investment in debt instruments also decline to Rs. 740.70 cr in Jun’10 from Rs. 4014 cr in May’10.
May end saw tight liquidity conditions prevailing on the back of huge 3G auction outflows, forcing the RBI to come out with ad-hoc measures to ease liquidity conditions like : i) conducting second LAF on daily basis and; ii) the additional liquidity support to scheduled commercial banks under the LAF to the extent of up to 0.5% of their net demand and time liabilities (NDTL) for SLR purpose. Initially these measures were announced for month. By June end, RBI extended these measures up to July 16, 2010. Apart from these, RBI reduced the amount for T-bill auction for 91 days, 182 day and 364 days, which has resulted in providing cushion of Rs. 22,000 cr during the month. Although these measures helped in improving the liquidity conditions, the overall system liquidity was negative throughout the month and banks were net borrower of around average Rs. 47,000 cr as against being net lender of average Rs. 33,000 cr in May’10 on the back of advance tax outflows, broadband auctions and quarter end requirements.
 

Outlook

We expect liquidity to improve during July on increased Government expenditure, large G-Sec maturities and lower than scheduled T-bill auctions. Similarly, we expect the G-Sec yields to be range-bound during the month ahead of RBI policy meeting. 10 year benchmark G-Sec is likely to be in the range of 7.50% and 7.70% during the month. Although large G-Sec auction of around Rs. 53,000 cr are scheduled for the month of July, huge G-Sec redemptions (around Rs. 43,000 cr) and lower T-bill roll-over (around Rs. 20,000 cr) will provide cushion to G-Sec yields. Rising inflation and robust economic growth numbers, however, increases the risk of rate hike in the RBI policy meeting and thereby affecting the yield curve. Going forward over next 3-4 months, we expect the yields to soften as the borrowings pressure comes down, fiscal situation improves on better than expected 3G and BWA auction revenues, inflation coming down on higher base and expectations of good monsoon.

Common Source for Debt Market View: RBI, CMIE, Bloomberg

By: Mr. Prashant Pimple - Fund Manager, Debt.

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