DSP Converse April 2024

REPO rate unchanged at 6.5%

Stance retained at “focused on withdrawal of accommodation”

• ✓ By a majority of 5 out of 6 members

Inflation Projections unchanged for FY25 at 4.5%

• ✕ Increasing incidence of climate shocks and low reservoir levels (in southern states) pose concern
• ✕ Tight demand supply conditions in certain pulses, prices of key vegetables & crude oil need close monitoring

Real GDP growth projection unchanged for FY25

• ✕ Headwinds from geopolitical tensions, geo-economic fragmentation, volatile financial markets & rising redsea disruptions

To review LCR framework for banks

H1FY25 borrowing calendar mildly positive

• ✓ Gross supply at 53.1% of total borrowing for FY25
  • Lower than last 5 years
• ✓ Skewed towards 10Y and ultra-long duration
  • Where the demand is expected to be

Higher than expected Q1FY25 SDL borrowing

• ✓ At 2.54 lac crores
• ✓ However, actual issuance has been 50% lower so far

The US jobs market showing resilience

And the same is true for inflation as well

US Fed needs “greater confidence” to cut rates

• Even as the data showed resilience in Feb-Mar, rate cut remained in play (Mar policy)
• Incoming data has further strengthened since then
• Fed fund projected rates now pricing-in just 1 rate cut in CY24 vs 3 rate cuts during last converse

Mar CPI moderates to 4.85% (5.1% in Feb)

• Back below 5% mark after 4 months
• Led by lower food & fuel inflation
• Crude oil prices and higher non-energy commodity prices pose upside risk

Core continues to provide comfort

• Moderates further to 3.3% (3.4% in Feb)
• Lower on M-o-M basis as well at 0.2% (0.3% in Feb)

Do yields track inflation projection? No.

• Orange area (chart) is 10Y yields, Blue line is CPI

Can forecasters predict Indian CPI? No.

• Green line is forecasters CPI 1-Yr ahead prediction
• Blue line is where inflation actually came
• Guess the error of margin!

CPI forecast corelated (not causality) to yields

• Low predictive power, high current corelation

Watch out for domestic growth

• PMI continue to be in expansionary mode
  • ✓ Manufacturing PMI at 16y high
• Mar sees 2nd highest GST revenue at 1.78 lac crores (up 11.5% YoY)
• Early Q4 commentary highlight continued caution

Overall credit growth remains strong at ~20%

• Unsecured loan growth has slowed down
• Pickup in housing and credit to large industries
• Services growth remains strong

How closely do yields track growth?

• Yields have usually tracked GDP growth, with correlation stronger when growth slows, barring
  • ✓ 2013, rupee depreciation and debt outflows
  • ✓ 2017, during demonetization

FY24, growth may not be big driver for yields

• FY23 GDP growth at 7.2% -in line with RBI projections.
• Q3FY24 GDP Growth came in at 8.4%.

States cash balance remains above 2 lac crores

Center has front-loaded devolution of tax

Issuance is expected to be lower than calendar

Actual SDL borrowing in line with expectations

• Borrowing higher than the calendar only when state cash balances dipped below 2 lac crores
• YTDFY25 issuance 50% lower than calendarized

With high states cash balances SDL issuance impact is expected to be limited

Banks SLR holding dips lower to 29.17%

• Banks SLR holding slips further lower
• Partly due to G-sec redemptions

The current pace of purchases is expected to continue

• As natural NDTL growth will still lead to demand

Yields usually track RBI OMO purchases

• Yields have strong correlation with RBI OMO
• Demand/Supply mismatch is filled in by RBI

RBI softened its liquidity management stance. However,

• Liquidity continues to remain tight despite VRR operation by RBI
• Further intervention necessary to bring liquidity to neutral

So far Indian 10Y yields tracked US 10Y

• Except for times when UST has risen sharply

When correlation broke, RBI has acted

• Higher yields -> OMO announcement (Oct’23)
• Lower yields -> Liquidity infusion - VRR (Dec’23)

Expect correlation, but with lopsided beta

• If UST yield rise, IGB yields may rise somewhat
• If UST yield fall, IGB yields may fall significantly

Risk/Reward to play for lower yields

FOMC to give near term trajectory

• We go long duration in FOMC, aware that there may be transient spikes in UST yields

Banking system liquidity has tightened

• After a brief spell of positive liquidity period in the first fortnight of April
• This had led to significant compression of money market rates; which have been inching up again

RBI is very actively managing banking liquidity

• Continuous VRR and VRRRs to maintain call rates closer to policy rate
• This is a reaffirmation of MPCs existing stance

Expect banking system liquidity to remain tight

• Absence of significant govt. spending has led to tight liquidity
• Until the end of elections we do not anticipate significant spending to come in
• Intervention by RBI in the forex market to protect INR has also caused liquidity to tighten
• However, we are almost at the beginning of CIC reversal season which will aid liquidity

Term premium falls sharply before rate cuts

• This time, the slope of the fall is much less
• If rate cuts get priced, the spread of 70bp will be high

Why do we prefer slope, not absolute levels?

• The slope removes the underlying demand/supply dynamics and thus can be compared across time

Even absolute levels are attractive

• Even absolute levels are attractive from prior regimes preceding rate cuts

Term premia: function of demand/supply and rate expectation

• During covid term premia high
  • Supply high: Govt increased fiscal deficit
  • Repo rates were expected to rise
• Post covid term premia fall is natural
  • Supply low: reduced FY25 supply, FPI flows
  • Rates are expected to fall

The trend of high demand, low supply strong

• Unlikely that govt will leave fiscal consolidation

DSP Surprise Index to identify high risk times

• During these times, “random” and unpredictable risks are higher than usual.

DSP Surprise Index identifies when the markets are surprised by data (US)

• Chose 8 indicators from inflation, growth and labor.
• Post covid, we are still in high uncertainty area

In last 1-Year

• The index spiked in Feb 23, Oct 23 and Apr 24
• During these times, the markets were most volatile
• We found our funds had reasonable underperformance

Interpretation

• During high DSP Surprise Index times, we would prefer to rationalize our risks.
• During low DSP Surprise Index times, we would prefer to run conviction trades

Supply has remained manageable so far

• Issuance in FY24 has increased by 14% compare to previous FY. Total Issuances has touched INR 8.15Lakh crore.
• Supply in AAA PSU and NBFC has grown moderately by 6-8%, whereby Corporate Issuances has sharply moved up by 70%.
• Supply in March lower (sequentially) at ~79k crores
• 2-3Y NBFC Spreads are at high of 100-110 bps, whereby AAA PSU spreads are currently at 50bps.

Corporate bond spreads steady

• In FY24 Corporate spreads moved in 45-65bps and NBFC Spreads remained steady at around 100bps.
• Long Term Issuances will continue to be well bided by real money investors.
• Issuances concentrated by large issuers like NABARD, SIDBI, PFC and some bank bonds
• Primary supply will pick up from Mid May especially from AAA PSU Segment.