Rahul Pal

Head - Fixed Income

The Government appointed Dr Urjit Patel as the new Governor of the Reserve Bank of India. Ending months of speculation, the Government preferred a continuity of leadership at RBI .As a Deputy Governor , Dr Urjit Patel was heading the Monetary Policy department within RBI.

If we were to read a bit into Dr Patel’s thought on monetary policy role on managing inflation, it would be interesting to take cognizance of a working paper he had published in 2012. In January 2012, on Global Economy and Development at Brookings (working paper 48),   Dr Patel had co-authored a  working paper “ Dynamics of Inflation “Herding””. The introduction to the working paper starts “From a broad scanning of the Indian Economy, it is not difficult to misinterpret Indian economic mangers’ attitude towards inflation, for the most part, cynical.” In the same paper they go on to say” It would seem that India has decoupled when it comes to price behavior; therefore assertions that imported inflation and external developments –like global excess –lies at the root of price developments in India ring hollow.”

Dr Patel, we think, may continue to maintain an argus eye on inflation. It may also be interesting to note how the conduct of the monetary policy moves hereon as his tenure will be marked by a huge paradigm shifting in the conduct of the monetary policy from an individual centric (Governor of RBI) to a committee centric (Monetary Policy Committee) with clear inflation targets outlined.

Welcome the new Rex!

The Rainfall.. small creases of worry

The nation slipped into a marginal deficit (-3%) on the cumulative Seasonal Rainfall (June 1 to August 31, 2016)^. In its weekly weather update for the week ended on August 31st 2016, the Indian Meteorological Department, informed that the cumulative rainfall at 693.2 mm deviated by 3% from the normal of 714.1mm. September would be a crucial month to watch out for; accounts for almost 20% of the seasonal rainfall. Well certainly a prayer on the lips!

The sowing area continued to be robust; the total area sown (as on September 2nd, 2016) increased by around 3.70% with pulses recording a growth of 33% (Karnataka and Rajasthan increase in pulse sown area around 50%) in sowing area. Sugarcane and cotton sowing area fell around 11% and 8% respectively.

Data Source: IMD website

The Markets : Firm and Robust

The Fed Chair spoke on August 26, 2016 at Jackson Hole,Wyoming .” I believe the case for an increase in the federal funds rate has strengthened in recent months” comment had a very limited impact on the global risk appetite. (That was the noise; her speech was on “Designing Resilient Monetary Policy Frameworks for the future” makes an interesting read)

The RBI Governor too presented the third bi-monthly monetary policy and kept the rates unchanged and also continued warning about upside risk to inflation.

The markets though stayed on course.

Bond and Money Market

We present a matrix detailing some movement in some key market rates (domestic and global) and key economic indicators:

Source: Bloomberg

Robust liquidity prompted a fall in rates across the yield curve: with short term rates dropping by around 15 basis points (bps) and the 5 year AAA corporate bond curve dropped around 12 bps to close at 7.52% pushing spreads between sovereigns down to an uncomfortable 33 bps.

The Sovereigns were quiescent dropping by around 6 bps during the month.

Equity Markets:

We present a matrix detailing some movement in some key market indices (domestic and global):

Source: Bloomberg

Nifty went up 1.71% in last one month. The biggest gainers were metals, banks and Auto.The market continue to favour domestic focused and pro cyclical companies due to significant liquidity and favourable india specific factors. The export sector IT and pharma underperformed. The tailwind for global export companies regarding weak demand, currency fluctuations continue and investor appetite continue to be weak in these sectors.

And Curate’s Egg: Some more data points

August was a busy domestic data and economic news month: but a bit of a curate’s egg : good in parts.

  • Inflation for July 2016 represented by Consumer Price Index (CPI) printed higher at 6.07% .Food inflation continued to be the bugbear with Consumer Food Price Index (CFPI) surging to 8.35%.
  • However the prices for pulses and vegetables ( the points of pain) have seen a sharp fall in prices in August and thus may provide some respite in the August reading of CPI.
  • GDP growth at constant prices in Quarter 1 of 2016-2017 was estimated at 7.10 percent with the Gross Value Added at 7.30 percent. While the numbers were below the market estimates, the worrying part came analyzing the expenditure side of GDP: Gross Capital Formation expenditure (at 2011-2012) actually showed a negative growth of around 3% .The heavy lifting was done by a sharp increase in Government Consumption expenditure which registered a growth of around 19% in the first quarter ;something which is unlikely to sustain in the coming quarters
  • Fiscal Deficit for the first four months was at 74% of the annual target for 2016-2017 (source CGA). What is worrisome is that this number is the highest in Nine years if similar numbers for the first four months are compared  for the past. This was also reflected in the large increase in Government consumption expenditure in the GDP growth numbers. In light of further payouts in lieu of the roll out of the pay commissions awards we would watch this data.
  • The good news was that the constitutional amendment bill on GST was passed in Parliament and was also ratified by 15 states setting the motion for constitution of the GST Council. The  tricky part of setting the rates start now !

    Data Source: MOSPI, CGA

Quo Vadis

Debt Markets:

The short term rates have come off significantly and may have almost priced in the easy liquidity. Any further drop in short term rates may look unlikely with the lower bound held by the repo rates at 6.50%.

Further tax, spectrum auction, FCNR (B) deposits and possible busy credit season may keep a tight leash on liquidity thereby possibly creating an upward bias of short term rates.

The buying of sovereigns through OMO and the collateral liquidity may help short term gilt rates to remain benign. With spreads of AAA rated corporate too trading at narrow spreads, there remains a probability of short term gilt rates offering a better risk return trade off. Further there exists a possibility of lower printing of headline inflation numbers thereby helping the possible easy bias in short term gilts.

Equity Markets:

Last six months bull run is driven by lower rates, falling risk premium and improving macro factors and improving earnings

Equities continue to react positively to global cues. In the month of August FII invested 9800 Cr in the Indian equity market. India continues to gain from global risk on trade. The zero to negative interest rates globally continue to encourage global investors to invest in equity markets in search of better yield.

Various policy initiatives like GST, Bankruptcy code by government has improved the medium term outlook on the country. Various macro parameters like CAD, Fiscal Deficit and positive real interest rates, falling government yields continue to show encouraging signs for equity markets

Various Sector specific parameters like Auto demand, cement prices, payout of seventh pay commission have shown positive signs for domestic demand. After two years of lull earnings, the first quarter earnings surprised positively. The Profit growth was much better than anticipation. The expectation is that the earnings momentum may continue on the back of operating leverage and marginal pickup in demand in certain segment. The market consensus expectation is that the earnings in two years could show higher double digit growth.

Due to the quick run up in markets, valuations look close to fair value. There appears to be pockets specifically in midcaps where some excess valuation froth may have started to creep in. Any global risk off trade could impact these segments.

The key risk to the markets is sudden hike in global rates or increased volatility in crude prices. Such situations occur then in short term there could be a possibility of flows reversing. In such markets, individual stock selection is the key.


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