Published on 10/10/2017 4:36:42 PM | Source: Quantum Tax Saving Fund

Debt Outlook Pankaj Pathak By Fund Manager Fixed Income Quantum Liquid Fund & Quantum Dynamic Bond Fund

Posted in | #Mutual Fund #Expert Views #Pankaj Pathak

The Indian bond yields grinded higher in September. The ascent in yields was in line with the up move in global yields after US Federal Reserve started the process of trimming down its USD 4.5 trillion balance sheet. Media reports said that government may expand fiscal deficit to stimulate growth also hit the market sentiment. The 10 year benchmark bond yield rose by 14 basis points (100 bps = 1%) to end the month at 6.66% as against the close of 6.52% in previous month.

The Monetary Policy Committee (MPC) of the RBI kept the policy rates unchanged at 6% with a vote of 5-1. It retained the neutral stance with the objective of keeping the CPI inflation near 4% (with +/- 2% deviation), while supporting growth.



Though the move was broadly in line with our expectation but we anticipated a dovish tone from RBI reflecting on slower economic momentum. The RBI did not pay much heed and seemed optimistic about the growth recovery. It did, though, cut its GVA estimates down to 6.7% from 7.3% for FY 18. It also raised the CPI projection for H2FY18 marginally to 4.2%-4.6% and highlighted upside risk to inflation from farm loan waivers and fiscal slippage.

Consumer Price Inflation for the August rose to 3.36% yoy (vs 2.36% in July) on the back of cyclical increase in food prices and sharp upward revision in prices of petrol and diesel. The core inflation which excludes food and fuel also shown sharp uptick in August primarily due to hike in house rent allowance under 7th pay commission and initial effects of GST implementation. Going forward as the base effect dissipates and the full effect of HRA revision shows up, we expect the CPI inflation will move towards RBI’s medium term target of 4% by Q3FY18 and move up further to around 4.5% by March 2018. These projections include the direct statistical effect of HRA hike for government employees which RBI has long communicated that it will look through. Excluding housing from the headline CPI and recalculating CPI-ex housing, suggests that CPI will remain below the 4% target and thus offer Real Interest Rates of well more than 2%.

Liquidity with commercial banks remained in surplus to the tune of Rs. 2 trillion. We expect that liquidity surplus will come down as currency withdrawal from banks may increase during the festive months of October-December. However, the liquidity situation may still remain in surplus mode and RBI needs to continue the OMO (Open Markets Operations) sales to bring it to neutrality.

Developed market central banks remain on track of policy normalization as economic data continued to be supportive. US Federal Reserve initiated the program to normalize its balance sheet which swelled to USD 4.5 trillion following Quantitative Easing (QE) programs post 2008 financial crisis. Beginning this month, it would reduce the holdings of US treasury bonds and mortgage-backed securities at a pace of USD 10 billion a month which will increase to USD 50 billion a month gradually. Additionally, the Fed was slightly hawkish on rates front and indicated a possibility of a rate hike end of 2017 and three hikes in 2018. European Central

Bank (ECB) may also reduce the amount of bond purchases as economic data continue to surprise on the upside. Bank of Canada and Bank of England are also moving on the path of tightening.



Despite the rollback of accommodative policies in developed economies, we expect that high real rates and comfortable balance of payments position will continue to attract foreigners into Indian debt market. Going ahead the bond market will face some tough times as fiscal and inflation risk play on investors mind in the backdrop of no monetary support from the RBI. However, valuations have become attractive after the recent sell off.

Any increase in fiscal deficit remains the most critical risk to sentiment towards bonds and will be the key metric to track. A large increase (more than 0.5%/GDP) will be seen very negatively by the bond market and can lead to a further sell off in bonds. Anything less than that can be absorbed by the market even at current levels.

In the current inflation targeting regime of 4% (+/-2%) Headline CPI Inflation + (1%-2%) Real Interest Rates, there is very little chance for the Repo rate to meaningfully go and sustain below 6%. In view of this we maintain our medium term neutral stance over rates. However, we will keep looking for signs mispricing in market and will positioned to exploit the opportunity tactically.


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