Debt Market Review

Mr. Avnish Jain
Head - Fixed Income

Fixed Income Market Outlook
Global Economy Update:

The pace of global growth has tapered off in recent months amidst volatile financial conditions and persisting uncertainty surrounding the geo-political situation. Heightened recession risks are shadowing aggressive and synchronised monetary tightening across jurisdictions. In its July 2022 update of the World Economic Outlook (WEO), the International Monetary Fund (IMF) revised down its global growth projection by 40 basis points (bps) for 2022 and by 70 bps for 2023 to 3.2 per cent and 2.9 per cent, respectively. In a downside scenario characterised by a drastic fall in energy imports from Russia, elevated and persistent inflation expectations and tighter financial markets conditions, global growth may fall further to about 2.6 per cent and 2.0 per cent in 2022 and 2023 respectively.
Indian Economic Growth:
In India, supply conditions are improving, with the recent monsoon pick-up, strong momentum in manufacturing and a rebound in services. The onset of festival season could boost consumer demand, including rural, also as sowing activity picks up. Robust central government capital outlays are supporting investment activity. Inflation has edged down from highs, but its persistence at elevated levels warrants appropriate policy responses to anchor inflation expectations going forward.
Government data showed that India’s gross domestic product (GDP) grew 13.5% on a yearly basis for the quarter ended Jun 30, 2022, as compared to a growth of 20.1% in the same period of the previous year. However, economists expect the pace of India’s economic growth to sharply slow in the next few quarters as higher interest rates hit economic activity.
Government data showed that the combined index of eight core industries grew 4.5% in Jul 2022 as compared to a growth of 13.2% in Jun 2022 and a growth of 9.9% in Jul 2021. All sectors witnessed growth except crude oil and natural gas sector.
India’s Index of industrial output (IIP) grew 12.3% YoY in Jun 2022 slower than 13.8% rise in June 2021. As per the sectoral classification, manufacturing sector rose 12.5% YoY from 13.2% in the year ago period. Mining sector growth eased to 7.5% from 23.1% while electricity surged to 16.4% from 8.3%.
According to S&P Global, India’s Manufacturing Purchasing Managers’ Index fell to 56.2 in Aug 2022 from 56.4 in Jul 2022. India’s manufacturing sector continued to grow in Aug, with new orders and production reaching their highest levels since Nov 2021.
Data from Reserve Bank of India showed that reserve money grew 10.3% on a yearly basis for the week ended Aug 26, 2022, compared to an increase of 15.2% in the same period of the previous year. The currency in circulation grew 8.1% on a yearly basis for the week ended Aug 26, 2022, compared to an increase of 9.8% in the same period of the previous year. The finance ministry reports that increased demand, higher rates, and more compliance helped India’s goods and service tax (GST) collection increase 28% to Rs. 1.43 trillion in Aug 2022. For the sixth consecutive month, in Aug, the collection exceeded Rs 1.4 trillion, and the next festival season is likely to support the trend.
Regulatory & Government Initiatives:
SEBI proposed blue bonds as a form of sustainable financing, with the agency claiming that these securities can be used for a variety of blue economy-related activities, such as the exploitation of maritime resources and sustainable fishing. Sebi has also advised broadening the scope of green debt securities and improving disclosures to strengthen the framework for green bonds.
The central government imposed export restrictions on maida, semolina, and all varieties of wheat flour from Aug 14, 2022. These measures have been taken due to a sharp increase in domestic wheat prices since Mar 2022 amid limited production and a steep decline in official procurement.
Inflation:
US Inflation: After reaching a 40-year high of 9.1% in June, the annual inflation rate in the US dropped down more than anticipated to 8.5% in July 2022. However, the core inflation excluding food and energy inflation remained steady at 5.9% thus offering an indication that the US inflation levels might have peaked.
India’s Inflation: India’s inflation is on the backfoot. For the third month in a row, India’s consumer price index-based inflation (CPI) eased to 6.71% in Jul 2022 as against 7.01% in Jun 2022. Consumer Food Price Index (CFPI) also eased to 6.75% in Jul as compared to 7.75% in Jun.
While Fuel and light inflation and inflation in education accelerated to 11.76% from 10.39% and 5.02% from 4.51% respectively in Jun 2022, it slowed down for food costs (6.75% vs 7.56% in June), transportation and communications (5.55% vs 6.9%), and health (5.45% vs 5.47%).
RBI Monetary Policy Update (August 5, 2022):
The monetary policy outcome was at higher end of expectations with the monetary policy committee (the MPC) hiking repo rate by 50bps to 5.40%. In past few days, rate markets had rallied with 10Y touching a low of 7.11% at start of the MPC announcement, on expectations, that considering the global concerns on recession in advanced economies (AEs), the MPC may indicate less aggressive policy stance. With focus on bringing down inflation to MPC’s range on 2%-6%, the committee continued to provide guidance of “to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.”
The MPC continues to focus on inflation and with pressure on currency continuing, in face of strong dollar, elevated commodity prices as well large FII outflows since start of 2022, normalization of ultra-accommodative pandemic policy is likely to continue, till the MPC believes that the rate is in a restrictive zone. The MPC retained growth forecast for both GDP as well CPI inflation at 7.2% and 6.7% respectively. The committee noted the recent incipient signs of factors that could lead to softening of inflation, but considerable uncertainties remain. Hence, the MPC believes that with expectations of growth momentum sustaining, despite strong headwinds, continued adjustment of monetary policy is required to move towards medium term target of 4% inflation. The MPC is likely to continue its calibrated hikes in next few policies, with possibility of the reduction in quantum of hikes to 25bps, as 3 large moves have been frontloaded.
Export & Trade Deficit:
India’s merchandise exports rose 2.14% YoY to $36.27 billion in Jul 2022. Similarly, imports jumped 43.61% YoY to $66.27 billion in Jul 2022 due to over 70% rise in crude oil imports. Thus, trade deficit almost tripled to $30.00 billion in Jul 2022 as against trade deficit of $10.63 billion in Jul 2021.
Government data showed that India’s fiscal deficit stood at 20.50% of the Budget Estimates (BE) from Apr to Jul of FY23. The revenue deficit stood at 16.40 % of Budget estimate. Total receipts stood at Rs. 7.86 lakh crore or 34.4% of the budget target as compared to 34.6% in the corresponding period of the previous year.
Bond Yields & Spreads:
In the fixed income market, as on august end, bond yields fell as expectation of progress towards inclusion of bonds in global indices, boosted sentiments of market participants. Yield on the 10-year benchmark paper (6.54% GS 2032) fell 13 bps to close at 7.19% as compared to the previous month close of 7.32%.
Overall, the yield curve is pricing in continued easing of inflation, but with continued tightening of monetary policy in the period ahead, albeit at a slower pace, to bring medium term inflation towards to the 4% target Corporate bond yields softened in tandem with the G-sec yields across tenors and the rating spectrum. Credit risk premium as reflected in the spread of corporate bond yields over G-sec yields of equivalent maturities also declined marginally during the same period. Corporate issuance remained modest, with primary market issuances during 2022-23 so far (up to May 2022) remaining tepid at 0.33 lakh crore.
Credit Growth:
As per the data on sectoral deployment of bank credit, non-food bank credit registered a growth of 15.1% in Jul 2022 as compared with 5.1% a year ago. Credit growth to agriculture and allied activities improved to 13.2% from 11.1%. Credit growth to industry accelerated to 10.5% from 0.4%. Services sector credit growth improved to 16.5% from 3.8%, mainly due to improved credit offtake to ‘NBFCs’ and ‘transport operators’.
Fixed Income Market View:
The sharp concurrent tightening of financial conditions in advanced economies (AEs) is leading to recession fears in the US as well in other advanced economies. The recession concerns have led to softening of yields in the long end of the curve, as markets believes systematically important central banks, like the US Federal Reserve, may be compelled to change direction on tightening, if faced with recessionary trend. Inflationary pressures continue to remain in the US, with labour market continuing to remain strong, despite 225bps of tightening since March 22. The latest labour data shows unemployment rate at 3.7%, inching up a little from a low of 3.5%. This indicates that the rate hikes may finally be bringing down excessive tightening in markets. The FED is committed to bring inflation down and is likely to continue to tighten rates till the labour market shows signs of softening, possible pushing the US economy into a recession.
Indian bond market benefitted from changed global sentiment as well correction in oil prices from their highs. Buzz of inclusion of Indian government bonds in the JP Morgan Global bond index aided positivity. RBI chose to frontload rate hikes with a 50bps move in August 22 policy. After a brief sell off, market recovered on positive global cues, especially crude oil dropping below USD100/bbl. Strong FII inflows in equity in August has supported rupee, despite substantial weaking of global currencies in wake of continued US dollar strength, This likely supported positive sentiment as well.
Evolving global cues relating to geo-politics, US rates, and commodity prices, would likely continue to drive Indian markets. Market participants would closely track inflation prints for signs of moderation in momentum. All eyes are likely to be on the AEs, as they struggle to temper inflation in coming months. With US economy not showing any signs of moderation, the US FED may be pushed to hike another 75bps in Sept 22 FOMC meet. FED officials continue to push back markets on rate cut expectations for next year, indicating that rates may have to stay higher for longer in face of unprecedented inflationary environment, and even if there is pause in rate hike cycle, rate cuts are not on cards. Yields are likely to move in either direction driven by incoming data. Any negative data on growth would likely drive yields down whilst any indication of sustaining momentum in inflation could take yields higher.
10Y yield is likely to be in range of 7.10%-7.35% in the near term. Investors are advised to continue with their asset-allocation based investment in debt funds, based on respective investment horizons and risk appetite.
Source: RBI, MOSPI, CMIE, FIMMDA, NSDL, Bloomberg, ICRA Analytics Ltd.