The new ten-year benchmark, 7.26% GOI 2029, closed the month at 7.41%, 12bps higher than previous month end as market was disappointed by the budget, especially with higher borrowing in FY19 and gross borrowing number for FY20 in the interim budget. While the gross borrowing was increased by INR360bn for FY19 due to a 10bps marginal increase in the FY19 fiscal deficit to 3.4% of Gross Domestic Product (GDP), the gross borrowing for FY20 was kept at Rs. 7.1 trillion compared to market consensus of Rs. 6.6 lakh crores which led to concerns of higher duration supply.
The Consumer Price Index (CPI) for the month of January’19 stood at 2.05% compared to 2.11% in the previous month. The Consumer Food Price Index (CFPI) continued to remain negative at -2.17% compared to -2.65% in the previous month, mainly due to fall in prices of fruits, vegetables, pulses and sugar confectionary.
GDP for 3Q FY19, came in at 6.6% Y-o-Y continuing the protracted slowdown while 1Q and 2Q GDP numbers were revised down to 8% and 7% from 8.2% and 7.1% respectively. Much of the slowdown was caused by slower government spending, agriculture output growth, and to some extent, by private consumption. The government also lowered its advance estimate of growth from 7.2% to 7% for the full fiscal year. This implies a growth of 6.3% in the January-March, 2019, quarter.
A lot has changed in the world over the past few months. A theme we have focused on is the changing narrative on growth which has gone from a synchronized recovery till late 2017 to significant growth divergences over most of 2018 to a synchronized slowdown since late 2018. A relatively more recent development is around policy responses to this slowdown. The starkest turn there is from the policy maker that matters the most to the world; the US Fed. From a place of forecasting multiple further rate hikes and keeping its balance sheet run down on ‘auto pilot’, the Fed has come a long way in a matter of months. For one it has turned ‘patient’ on rates. Two, balance sheet run offs are expected to end sometime late this year. Three, the Fed is in the process of discussions and debate around policy tools available to it for the next downturn. China policy seems to have also turned with liquidity creation by the central bank and targeted credit getting stepped up, while the official narrative remains that they won’t go overboard with incremental credit. The European Central Bank (ECB) also seems to lately be getting perturbed by weaker growth over the past few months and may also soon undertake further rounds of long term lending operations. With these developments, the risk that policy makers are ‘asleep on the wheel’ while growth deteriorates is significantly lesser. This is positive for emerging market (EM) currencies insofar that on the margin the risk of a disruptive downturn to growth leading to safe haven bids for the dollar is lesser.
India itself is struggling with growth drivers, after trying for some rebound early in 2018. There are two specific channels that are incrementally affecting our growth prospects. The first obviously is the international situation. The second reason is largely domestic. Financial conditions are significantly tight with some notable underlying aspects. A part of the economy as represented by housing finance companies (HFCs) and non-bank finance companies (NBFCs) has absorbed a significant chunk of incremental funds flow over the past few years. Parts of this sector are suddenly faced with a risk perception deterioration leading to a spike in incremental borrowing cost as well as constrained fund availability. The other more general point is that falling inflation hasn’t been commensurate with falling interest rates thus leading to a generalized real rate shock for the economy. Thus in our opinion the bond market is largely shut for non-government borrowers and even for PSU entities 10-year money is available today only in excess of 8.5%. Given the expected nominal GDP growth rate of around 11%, this creates a huge disincentive for an average economic entity to borrow for discretionary reasons. Monetary policy has potentially turned more decisive under the new Governor. For now emphatic action may well be warranted and apart from rate cuts it is possible to envisage the central bank turning even more proactive on liquidity, especially if the growth – inflation mix remains as it is currently and the global backdrop remains sanguine.
Going Forward:
A benign global backdrop with an emphatic RBI Governor is ordinarily a bullish recipe for bonds. Certainly front end AAA corporate bonds between 2- 5 years are better placed in terms of risk versus reward to play this environment. The duration part of the curve has frustrated lately as the yield curve has incessantly steepened with market fearing supply absorption ahead. Our preference here, as indicated before, is via spread assets like State Development Loans (SDLs) and the best quality AAA corporate bonds. Spreads to equivalent government bonds are now in the vicinity of 100 bps for these bonds. Also, the relative excess supply here fades seasonally over the next two quarters. Market for lower rated credits remains dislocated and we would continue to advise caution there. There is a genuine liquidity issue in the lower rate space and this is constraining true price discovery as well. One will have to wait for some of these issues to settle down, and in particular allow price discovery to start happening through the open market, before taking any sort of a serious relook at this space.