DSP Converse October 2023

• The US job market has weakened

• And is now percolating to inflation

• Oil has retraced from 90+ levels

• US rate hike expectations now out of the way

• Inflation moderated in-line with expectations

  • Oct print came in at 4.87% vs 5.02% in Sep
  • Sequential uptick of 0.7% (vs -1.1% in Sep)
  • Food inflation overall remains sticky
    • ✓ Led by cereals, pulses and spices
  • Upside risks remain due to
    • ✓ Geopolitical conflicts & uncertainty on rabi sowing (low reservoir levels)

• Core CPI continues it’s downtrend

  • Came in at 4.3% vs 4.5% in Sep

• 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 is in expansionary mode, but sequentially lower
  • GST collections at ₹ 1.72tn (2nd highest); up 13% YoY
  • Outlook commentary in Q2 has been divergent. E.g.:
    • ✓ FMCG (urban↑, rural↓), Auto (PV ↑, 2-wheeler ↓), Apparel (luxury ↑, value ↓)

• Loan growth still near decadal high

  • Led by retail and services segment
    • ✓ Revised lending norms might impact this
  • Credit growth to large corporates remain sluggish

• How closely do yields track growth?

  • Yields have usually tracked GDP growth, with correlation being 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 came in at 7.2%, in line with RBI projections.
  • Q1FY24 GDP Growth came in at 7.8%.

The checklist for pause:

• When the US Fed starts pausing

  • Reduces risk of capital outflows

• When inflation is within comfort

  • Reduces risk of inflationary policy
  • Barring 2014 (refer to the dotted area), when RBI did not have 6% CPI target
    
    • ✓ But CPI was falling in 2014

• When BoP (and currency) is stable

  • Reduces inflationary / external risks

How is the checklist now?

• ↔ US markets indicating no more hikes

  • Even though FED remains data dependent
  • FED to remain on “WAIT and WATCH” mode

• ↔ Inflation not a worry as of now

  • Headline as well as Core CPI is easing
  • Although uncertainty remains

• ↔ BoP is stable, but rupee has fallen

  • BoP in surplus in Q4FY24
  • But rupee remains vulnerable to EM reaction

• RBI FX reserves have reduced lately

  • Forex reserves reduced to ~$591bn from $640b+ during covid peak

• IMF FX adequacy metric for CY23 announced

  • FX adequacy ratio declined from 180% to 170%
  • However, a buffer of almost $70 bn to reach 2013 and 2018 levels (~150% ratio)

• RBI only hiked rates twice in past 10 years, barring latest cycle

  • Increased rates to control rupee, not inflation

• RBI has tolerance for inflation, not rupee fall

  • In 2018, inflation was within RBI’s target levels
  • In 2013, inflation was high for long yet RBI cut

• When RBI FX reserve fall

  • RBI switches from using reserves to rate hikes to control rupee.

• BoP is probably worse

  • FX reserves low despite MTM gains (UST ↑, Gold ↑)

• Trade deficit widens in Oct ($31bn vs $19bn )

  • Led by imports (12.3% yoy) against exports (6.2% yoy)
    • ✓ Festive gold/silver demand
    • ✓ High oil imports (lower Russian oil discount)
  • Expected to normalize in from current levels
  • Services surplus remains firm

• Rupee seems to track EM currencies

  • INR Depreciation in line with EM currencies (chart)

• But this is not true picture…

  • Flatline USD/INR indicates RBI is setting price
  • INR would have underperformed EM but for RBI

• We are not yet concerned.

  • Bond inclusion flows around the corner

• FPI demand seem insignificant to total supply

  • Assuming supply higher by just 6-7%
  • Non-discretionary buying growth at 14-15%
    • Non-discretionary => need to buy for regulation (Insurance/PF/NPS/Bank-LCR) no matter the yield
  • Rs. 2 lac cr. of FPI flow may seem pittance in from of Rs. 19 lac cr of supply

• … yet FPI inflow is mammoth

  • Supply available for discretionaries is less in FY25
    • Bank non-discretionary demand growing faster
  • But the demand from discretionary will increase
    • Discretionary = Look at yields to buy i.e.

• Its not share of supply that matters

  • It’s the share of residual supply
  • That’s why, OMO fear of < Rs. 1 lac cr rose yield by 20bp

• State cash balance hovers around 2tn mark

• Center has front-loaded devolution of tax

• Issuance is expected to be in line with the calendar /marginally lower at best

• Actual SDL borrowing in line with expectations

  • Higher than the calendar only when state cash balances dipped below 2 trillion
  • 7mFY24 issuance ~12% lower vs the calendar amount
    • Oct’23 issuance 24% higher vs the calendar due to lower than 2tn state cash balance

• SDL issuance impact is expected to be limited

• Banks SLR holdings has risen sharply

  • Banks SLR holding remains high (>30%)

• Banks have bought nearly ₹ 5 tn in 7mFY24

  • But this includes bump of HDFC merger

• And the same pace 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 announced possibility of OMO sales

  • Already sold ~8.5k crores since then (dotted area)

• Uncertainty on OMO size and time

  • Liquidity will remain tight till Dec mid
  • Yet, by Jan liquidity will be in surplus as Govt will have less need to keep cash post maturities

• FOMC rate at 5.50% - more hikes at play?

  • Not any more, further rate hike probability at “0” now
  • Data has finally weakened

• Are spreads of US Treasury and Indian Govt. Bonds low?

  • Yields spread mimics inflation and policy rate spread.
    • ✓ Currently divergence with inflation spread.
    • ✓ US CPI is falling so correction may come from fall in US yields rather than rise in India yields.

• Are Indian yields tracking US Rates? Yes

  • After a brief period of negative correlation, Indian yields again tracking US yields

• What led to correlation again?

  • RBI OMO announcement

• Durable liquidity is sufficient at ~₹ 2.6* tn

  • However, banking system liquidity remains in deficit of ~₹60k crores
    • ✓ G-sec maturity of ₹ 2tn in Nov/Dec
    • ✓ And month end Govt spending, after adjusting for scheduled outflows, to push banking system liquidity to surplus zone, though not significantly

• CIC is typically higher in October and November due to festive demand

• We saw a CIC drag of ₹ 73k crore from October onwards

  • Typically first fortnight of December also sees CIC outflow in the range of ₹ 15-20k crores

• State elections to further tighten liquidity

• Supply has remained manageable so far

  • H1FY24 issuance at ~1.3x of H1FY23 led by AAA rated segment
  • Supply in Oct remained on the lower side at ~40k crores

• New NBFC regulations to lead to more issuances

  • NBFC to shift part borrowing to bonds form bank loans
  • Will lead to rise in NBFC spreads of some companies

• The corporate bond spreads are reasonable

  • 2-5Y NBFCs providing steady accrual
    • ✓ But tight liquidity pressures remain
  • AAA PSU Spreads remain to be in the narrow band of 55-60bps
  • Spreads in short papers may remain elevated,
    • ✓ We still like long bonds: demand from insurance, PF