RBI will keep the Repo Rate status quo in its bi monthly policy review on the 6th and 7th of June. The MPC (Monetary Policy Committee), which had sounded caution on inflation in the April meet, will remove the “Upside Risks to its CPI Inflation forecast of 4.5% to 5%”, which will be taken positively by the bond markets. RBI will not change its policy stance from neutral to accommodative as its inflation target is 4% and its forecast for inflation is 4.5% to 5% for this fiscal year.
RBI has foreseen a weak GDP growth number for the 4th quarter of fiscal 2016-17 and also falling CPI for the first half of this fiscal year. GDP growth at 6.1% for the 4th quarter against 7.1% for full year 2016-17 was largely due to the effects of demonetization. RBI sees this as transitory and expects growth to pick up in the 1st quarter of this fiscal year. CPI inflation at 2.99% for April 2017, the lowest on record, too will not make the RBI change its neutral stance.
RBI focus will be on lowering the excess liquidity in the system, which is currently at around Rs 5500 billion. Demonetisation liquidity overhang coupled with RBI fx purchases and government spending is keeping system liquidity high. RBI has stated that its liquidity target is around +/- 0.25% of NDTL, which is around Rs 250 billion to Rs 300 billion. It is using variable rate reverse repos and MSS/CMB bonds to suck out excess liquidity. RBI is also postponing liquidity impact of fx intervention by buying forward USD.
Inflation risks are ebbing away with GST rates being benign, monsoons on track and oil prices staying steady globally. The only two factors that RBI will highlight on inflation risks are 1. Rental impact of 7th pay commission implementation and 2. Narrowing of output gap given that exports are picking up with high double digit growth over the last two months and domestic consumption demand picking up on the back of low interest rates and strong capital markets, with Sensex & Nifty closing at record highs last week.
RBI still has much work to do on banks balance sheet clean up and it will focus on measures for clean up in the policy review. High profile debt defaults such as Rcom, is hurting lenders and sentiments on credits. PFC’s sudden jump in 4th quarter NPA’s reflect the fact that many entities are under reporting stressed assets. RBI will have to address these issues to make reporting more transparent.
10 year US treasury yields closed at 2.17% last week, a multi month low, on the back of weaker than expected May job numbers. US economy added 138,000 jobs in May, down from 174,000 jobs added in April. Unemployment rate fell to 4.3%, lowest since 2001. Wage gains were as per expectations. Fed will hike rates this month but treasury markets are not concerned on rising inflation expectations at this point of time. RBI will view the fall in US treasury yields positively.
Government bond yields came off last week on the back of 4th quarter FY 17 GDP growth numbers. The new benchmark 10 year bond, the 6.79% 2027 bond saw yields close down 2bps week on week at levels of 6.62%. The old 10 year benchmark bond, the 6.97% 2026 bond, saw yields close down by 3bps at 6.75% levels while the on the run bonds, the 6.79% 2029 bond and the 7.06% 2046 bond saw yields drop by 3bps and 7bps respectively to close at levels of 6.80% and 7.28%. Gsec yields are likely to fall on the back of RBI removing its upside risk to inflation phrase in its policy review this week.
OIS market saw one year yield fall by 6bps and five year OIS yield fall by 7bps last week. One year OIS yield closed at 6.37% while five year OIS yield closed at 6.50%. OIS curve spreads fell by 1bps. The spread can fall further post RBI policy.
10 year benchmark AAA bond yields closed higher by 1bps at 7.61% levels with spreads up by 3bps at 88bps levels against the new 10 year benchmark gsec, the 6.79% 2027 gsec. 3 year and 5 year AAA spreads were higher by 4bps and 8bps at 64bps and 54bps respectively. Benchmark 3 year AAA corporate bond yields closed lower by 1bps at 7.32% levels. 5 year benchmark AAA bond yields closed higher by 3bps at 7.41% Bond markets were circumspect post the sharp rise in NPA’s of PFC, which is widely held by the market.
System liquidity as measured by bids for Repo, Reverse Repo, Term Repo and Term Reverse Repo in the LAF (Liquidity Adjustment Facility) auctions of the RBI and drawdown from Standing Facilities (MSF or Marginal Standing Facility and Export Credit Refinance) and MSS bond issuance was in surplus of Rs 5655 billion as of 2nd June 2017. The surplus was Rs 4174 billion in the week previous to last. Liquidity rose on the back of government spending and RBI fx purchases.
