Debt Market Review

Mr. Avnish Jain
Head - Fixed Income

Global Economy Update:

Global economic activity experienced a loss of momentum in Q2:2022, with most economies exhibiting contraction or deceleration as the outlook deteriorated. This was reflected in a sequential fall in the composite lead indicator (CLI) for OECD countries for 13 months in a row up to August 2022. Synchronised and aggressive monetary tightening, lingering uncertainty from geopolitical tensions, continued supply chain disruptions and multi-decadal high inflation were the major drags on growth. Both business conditions and consumer confidence worsened with the decline in the latter being more pronounced.
Indian Economic Growth:
Loss of momentum in global economic activity may be taking the edge off inflation, which remains elevated. The Indian economy is poised to shrug off the modest tapering of growth momentum in the first quarter of 2022-23. Aggregate demand seems firm and poised to expand further as the festival season sets in. Domestic financial conditions remain supportive of growth impulses. Inflation remains elevated and above the tolerance level, underscoring the need for monetary policy to keep second order effects contained and inflation expectations firmly anchored.
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.
According to the United Nations Conference on Trade and Development (UNCTAD), India's economy will increase by 5.7% in 2022 and 4.7% in 2023. In FY22, India's GDP increased by 8.7%. It stated in its annual Trade and Development Report 2022 that the global economy is likely to increase 2.6% in2022, which is 0.9% points lower than the rate projected in the previous year's report.
The Organization for Economic Co-operation and Development (OECD) retained its projection of the growth of the Indian economy at 6.9% for FY23. OECD further added that the growth of the Indian economy may come down to 5.7% in the next fiscal. OECD attributed India's projected slowdown to muted external demand. RBI projects GDP to grow at 7% in FY2023.
According to S&P Global, India's Manufacturing Purchasing Managers' Index fell to 55.1 in Sep 2022 from 56.2 in Aug 2022. India's manufacturing sector dropped due to a slowing in demand and output despite reducing inflationary pressures and robust business confidence. Input costs increased at the weakest rate since Oct 2020, and majority of businesses reported no change in purchase prices.
The provisional payroll data by the ministry of statistics and programme implementation shows that net new subscriber addition under the EPFO grew by 13% to 1.82 million in Jul 2022 compared to 1.61 million in Jun 2022.
S&P Global India Services Purchasing Managers" Index fell to 54.3 in Sep 2022 from 57.2 in Aug 2022. India's services sector fell in Sep 2022 amid substantial easing in demand amid high inflation. The overall S&P Global India Composite PMI Output Index slowed to 55.1 in Sep from 58.2 in Aug as both manufacturing and services sectors cooled on falling demand.
Data from Reserve Bank of India showed that reserve money grew 10.7% on a yearly basis for the week ended Sep 23, 2022, compared to an increase of 14.7% in the same period of the previous year. The currency in circulation grew 8.3% on a yearly basis for the week ended Sep 23, 2022, compared to an increase of 9.0% in the same period of the previous year.
Inflation:
Global: Inflation remained elevated much above targets/ tolerance levels in both AEs and emerging market economies (EMEs), driven up by energy and food prices. The US headline CPI inflation (y-o-y) moderated to 8.3 per cent in August 2022 from 8.5 per cent in July while core CPI accelerated to 6.3 per cent in August.
Euro area annual inflation shot up to a record high of 9.1 per cent in August, primarily driven by high energy prices followed by those of food, alcohol, and tobacco. CPI inflation in the UK eased to 9.9 per cent (y-o-y) in August 2022 from its double-digit peak in July due to moderation in motor fuel prices.
Among the BRICS economies, inflation in Brazil eased to 8.7 per cent in August from 10.1 per cent in July, while in China it eased to 2.5 per cent. In Russia, inflation softened further to 14.3 per cent in August from 15.1 per cent in July.
India: India's consumer price index-based inflation (CPI) rose to 7.00% in Aug 2022 as against 6.71% in Jul 2022 mainly due to higher food prices. The consumer price index-based inflation is above the Reserve Bank of India's comfort level of 6% for the eighth month in a row. Consumer Food Price Index (CFPI) also rose to 7.62% in Aug as compared to 6.69% in Jul.
India's Wholesale price index-based inflation (WPI) eased to 12.41% YoY in Aug 2022 as against 13.93% rise in Jul 2022. The decline came due to softening in prices of manufactured and fuel products, even as food items remained expensive. WPI based rate of inflation in the same period of the previous year stood at 11.64%. The growth of WPI Food index stood at 9.93% in Aug 2022 as against 9.41% in Jul 2022 and 11.78% in Jun 2022.
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 For 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:
Exports from India fell 3.2 percent year-on-year to USD 32.62 billion in September of 2022, the lowest in ten months as growth worries weighed on demand.
India current account deficit widened to $23.9 billion in the second quarter of 2022, the highest since the last quarter of 2012, and compared to market forecasts of a $30.5 billion gap. It is equivalent to 2.8% of GDP. The trade deficit increased sharply to $68.6 billion from $30.7 billion a year ago, as imports soar amid rising commodity prices and a strong dollar. Also, the primary income gap increased to $9.3 billion from $7.5 billion, amid an increase in net outgo of investment income payments. On the other hand, the services surplus widened to $31.1 billion from $25.8 billion, pushed by rising exports of computers, transportation, business, and travel services while the secondary income surplus went up to $22.9 billion from $19 billion.
The government has decided to lower borrowing for the current fiscal by Rs. 10,000 crores than earlier projected for FY23 in the budget.
According to data from the Reserve Bank of India, Indian IT service providers exported 88.8% of their software services via the offshore mode, up from 82.8% five years prior in in FY22.
Bond Yields & Spreads:
Bond yields fell, in early part of September, as expectation of progress towards inclusion of bonds in global indices gathered pace. Yield on 10Y bond (7.26% 2032) dropped to a low of 7.08% (from 7.18% at end of August). Latter part of September saw reversal of yields as market chatter on bond inclusion faded, and on reversal of global risk sentiments. 10Y closed the month at 7.40% on policy hike by the RBI MPC.
Overall, the yield curve is pricing in continued easing of inflation, but with continued tightening of monetary conditions in the period ahead, witnessed by continued rise in short term rates and subsequent flattening of the 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 Aug 2022) at Rs.1.91 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 3.00-3.25%, the fastest pace of increase in a very long time. 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 corrected sharply during the month, further supporting market sentiment. However, oil prices recovered from lows 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 reversed in September on global risk off sentiment, with rupee breaching the INR 80/USD mark and closing the month at INR81.34/USD. Rising oil prices in latter half of September further 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 4.50-4.75% 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.