Debt Market Review

Mr. Avnish Jain
Head - Fixed Income

Economy Review & Fixed Income Market Outlook Global Economy Update:

Aggressive and synchronised monetary tightening has further weakened global economic prospects as financial markets sold off, investors took fright and jettisoned risky assets. GDP in several parts of the world has either started contracting or decelerating. The prolonged geopolitical conflict and the likelihood of a harsh winter have amplified energy and food price shocks.
The International Monetary Fund in its latest World Economic Outlook (WEO), released on October 11, 2022 has projected global growth to slow from an estimated 6.0 percent in 2021 to 3.2 per cent in 2022 (unchanged from July 2022 WEO update) and 2.7 per cent in 2023 (revised down by 0.2 percentage points from July 2022 projection). These forecasts factor in a number of turbulent challenges that the global economy faces including multi-decadal high inflation, tighter financial conditions, conflict in Ukraine, lingering COVID-19 pandemic and slowdown in China. Moreover, the global inflation is projected to rise to 8.8 percent in 2022 (revised up by 0.5 percentage points relative to July 2022 WEO update), then moderate to 6.5 percent in 2023 (revised up by 0.8 percentage points relative to July 2022 WEO update) and further ease to 4.1 percent by 2024 – reflecting confidence that inflation will recede with tighter monetary policy.
Among high frequency indicators, global composite purchasing managers index (PMI) inched up marginally to 49.7 in September from August's 26-month low of 49.3 as services business activity stabilised while manufacturing output declined. The global manufacturing PMI fell to 49.8 in September from 50.3 in August, lapsing into the contraction zone for the first time since June 2020. Output fell in intermediate and investment goods sectors while business optimism sank to a 28-month low.
Indian Economic Growth:
In India, broader economic activity has remained resilient and poised to expand further. Domestic demand is accelerating, with auto sales having rebounded, real estate sales on the rise despite a pick-up in borrowing costs and the contact-intensive hospitality services experiencing a bounce-back.
Bank credit is increasing by double digits and the sustained surge in goods and service tax collections is signalling growing formalisation of the economy.
Indian equities are outperforming both advanced and emerging peers. Selling by foreign portfolio investors is being more than matched by domestic institutional investors' buying. Corporate and bank balance sheets have become fortified through the period of the pandemic.
There is a view that India is likely to be among the few emerging economies that would be left standing after the global hurricane has passed.
India's Manufacturing PMI increased to 55.3 in October 2022 from 55.1 in September, exceeding expectations for a slowdown to 54.9 and remaining above its long-run average of 53.7. The quantity of factory orders and purchases increased by historically significant amounts in October, while output growth beat the long-term average despite slowing to a four-month low.
The S&P Global India Services PMI was up to 55.1 in October 2022 from September's six-month low of 54.3 While employment increased for the fifth consecutive month and at the second-fastest rate in more than three years, new orders growth was noticeable and accelerated from September. Capacity pressures remained low in the interim as backlogs increased at a slow rate that was mostly consistent with September.
Government data showed that the combined index of eight core industries grew 7.9% in Sep 2022 as against 4.1% rise in Aug 2022 and 5.4% in the year ago period. Core output during Apr-Sep of FY23 rose 9.6% slower than 16.9% a year ago.
According to the Centre for Monitoring Indian Economy, the unemployment rate in India stood at 7.77% in Oct 2022 compared to 6.43% in Sep 2022. Rural unemployment rate stood at 8.04% in Oct as against 5.84% in Sep while the urban unemployment fell to 7.21% in Oct compared to 7.7% in Sep.
Data from Reserve Bank of India showed that reserve money grew 11.2% on a yearly basis for the week ended Oct 28, 2022 compared to an increase of 14.1% in the same period of the previous year. The currency in circulation grew 9.0% on a yearly basis for the week ended Oct 28, 2022 compared to an increase of 8.5% in the same period of the previous year.
The goods and service tax (GST) collection were reported second highest in October 2022, according to the recent data released by the Ministry of Finance. GST collection for the previous month stood at Rs 1.52 lakh crore.
Inflation Global:
Elevated inflation remains the major policy concern for most economies even though the recent fall in commodity prices has led to inflation coming off peaks in many countries. The US headline CPI inflation (y-o-y) moderated to 8.2 per cent in September 2022 from 8.3 per cent in August while core CPI inflation firmed up to 6.6 per cent in September. Inflation based on the personal consumption expenditure (PCE) index (Fed's preferred measure) was at 6.2 per cent y-o-y in August 2022, marginally down from 6.4 per cent in July on account of a favourable base effect.
Annual inflation rate in the Euro Area continued to break record high levels and jumped to 10.7% in October of 2022 from 9.9% in September. Prices of energy continue to have the biggest impact (up 41.9% vs 40.7% in September), followed by food, alcohol & tobacco (13.1% vs 11.8%), non-energy industrial goods (6% vs 5.5%) and services (4.4% vs 4.3%).
The annual inflation rate in the UK rose to 10.1% in September of 2022 from 9.9% in August, returning to the 40-year high hit in July and surpassing market expectations of a 10% rate.
Among the BRICS economies, inflation in Brazil eased to 7.2 per cent in September from 8.7 per cent in August, while in Russia it eased to 13.7 per cent in September from 14.3 per cent in August.
India: The annual inflation rate in India increased to a five-month high of 7.41% in September of 2022 from 7% in August, above market forecasts of 7.3%. Prices increased faster for food (8.6% vs 7.62% in August), with vegetables (18.05%), spices (16.88%), cereals and products (11.53%) recording the biggest rises as erratic rainfall impacted the local crops and supply shock from the Russian invasion of Ukraine remained.
The annual wholesale price inflation rate in India fell to 10.70 percent in September 2022 from 12.41 percent in the prior month, less than market estimates of 11.5 percent. This was the lowest reading since September 2021, amid a slowdown in prices of manufactured products (6.34% vs 7.51 percent in August), mainly basic metals (6.53% vs 9.35%); and fuel and power (32.61% vs 33.67%). Also, prices of primary articles moderated further (11.73% vs 14.93%) with cost of food easing (11.03% vs 12.37%).
RBI Monetary Policy Update (September 30, 2022):
In line with market expectations, RBI Monetary Policy Committee (MPC) raised repo rate by 50bps to 5.90%, while maintaining stance of “withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth”. Such a move was largely anticipated as global central banks have been raising rates aggressively in last 6 months to fight high inflation in developed economies, not seen in decades. While inflation in India has not been so high, it has still been above MPC's target of 6% since start of the fiscal 2023. However, inflation has been on downtrend after touching 7.8% in June 2022 and is expected to ease to 5% by 1QFY2024 (as per RBI projections). The MPC was in a backdrop of continued headwinds from geo-political tensions, tightening financial conditions, volatile currency markets as well as reversal of portfolio flows.
Indian macro conditions have been relatively better with sound GDP growth, and moderating inflation, though external sector has been under pressure due to high commodity prices, and portfolio outflows. However, the Indian currency has fared much better in comparison to some emerging market currencies as well as developed market currencies. Drop in crude oil prices has been a welcome development for India as it will help stabilizing the external sector as well likely will reduce inflation going forward. RBI MPC reduced the projection for GDP growth for FY2023 to 7% (from 7.2% in Aug 22 policy) whilst maintaining inflation projection of 6.7% in full year FY2023. RBI further expects inflation to fall to 5% in 1QFY2024.
Export & Trade Deficit:
India's overall exports (Merchandise and Services combined) in September 2022 are estimated to be USD 61.10 Billion, exhibiting a positive growth of 10.24 per cent over the same period last year. Overall imports in September 2022 are estimated to be USD 76.26 Billion, exhibiting a positive growth of 10.73 per cent over the same period last year.
India's overall exports in April-September 2022 estimated to be USD 382.31 Billion, exhibiting a growth of 21.03 per cent over the same period last year.
Estimated value of services export for September 2022 is USD 25.65 Billion, exhibiting a growth of 18.72 per cent vis-a-vis September 2021 (USD 21.61 Billion).
Bond Yields & Spreads:
Bond yields hardened in October on back of global rise in yields, reversal of falling oil prices, tightening liquidity due to festive season demand, and continued obstacles in India's bond inclusion in global indices.
The yield curve continued to flatten. Tightening liquidity had impact on short term rates, pushing them faster as compared to long end of yield curve.
Corporate bond yields fell/rose 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, except for upto 1 year segment, where corporate spreads have gone up. Corporate issuance remained modest though it gathered a little pace, with primary market issuances during 2022-23 so far (up to Oct 2022) at Rs.3.08 lakh crore.
Fixed Income Market View:
The sharp concurrent tightening of financial conditions in advanced economies (AEs) is leading to recession fears in large economies with risks of spill overs to emerging markets through global trade and financial linkages. Global yields continued the uptrend as global central banks vowed to fight inflation, even in face of recession. US Federal Reserve (US FED) raised rates again by 75bps, taking the funds rate to 3.25-4.00%, the fastest pace of increase in a very long time. Market data now indicates that terminal rate for FED funds rate to by more than 5%. Data of US economy continues to show strength, especially the labor markets, though the housing markets have seen correction. The strong labor market is likely to continue to push the FED to keep raising rates till moderation of inflation is seen on more consistent basis and labour markets show signs of easing.
As euphoria of index bond inclusion faded, yields reversed and rose during the month. Oil prices reversed course on as the OPEC+ chose to cut production output by a massive 2mbpd. This was probably necessitated on fears of recession impacting future oil demand. Strong FII inflows in equity in August 22 had reversed September 22 on global risk off sentiment but were moderately positive in October 22. The rupee continuing to depreciate and hit 83.30/$, before closing the month at 82.78/$. Rising oil prices in latter half of October added pressure on rupee slide as well as bond yields.
Evolving global cues relating to geo-politics, US rates, and commodity prices, would likely continue to drive Indian markets. Market participants would closely track AE inflation prints for signs of moderation in momentum, as global financial tightening is largely driven by systemically important central banks. With US economy not showing any signs of moderation, the US FED has projected to take the Fed funds rate to 5.00-5.25% by early next year. 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.
RBI MPC is likely to moderate its pace of hike, as inflation is expected to drop to 5% by 1QFY2024. RBI MPC may hike by 35bps in December 2022 and further by 25bps in February taking the repo rate to 6.5%, With liquidity likely entering the deficit zone, overnight rates may trade above repo rate, potentially adding more tightening on short end. Market yields are likely to be driven more by factors like global yield, oil price movements rather than local factors. In the short term, 10Y yield may trade in 7.30-7.60% range.
Source: RBI, MOSPI, CMIE, FIMMDA, NSDL, Bloomberg, ICRA Analytics Ltd.