Outlook – Fixed Income

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Outlook – Fixed Income

Gross Domestic Product (GDP) growth at 2-year high

The recent optimism witnessed in the Indian economy was evidenced in the Gross Domestic Product (GDP) reading; wherein the GDP growth rose to 5.7% year-on-year (YoY) in Q1 financial year 2014-2015 (FY14) from 4.6% YoY in Q4 – financial year 2013-2014 (FY13), higher than market expectations of 5.5%. Non-agricultural GDP growth rebounded to a nine-quarter high of 6.0% YoY in Q1, led by both the industrial and services sectors. Non-agricultural GDP growth rebounded sharply to a nine-quarter high (6.0% YoY in Q1 from 4.3% YoY in Q4 – FY13) led by a pickup in both the industrial (4.0% vs -0.5%) and services sectors (6.6% vs 5.8%) with recovery evident in output growth in the manufacturing, electricity and utilities, construction and community and personal services sectors. Agricultural growth moderated, but remained at a healthy pace (3.8% YoY in Q1 from 6.3% in Q4-FY13).

The Consumer Price Index (CPI) inches up owing to vegetable prices

The Consumer Price Index (CPI) rose to 7.96% YoY in July 2014 as against market expectations of 7.4%. The increase in price data was primarily on account of rise in vegetable prices. Although the vegetable prices would continue to contribute to elevated inflation readings; we expect overall moderation in coming month’s data owing to disinflationary trends in the CPI data ex of vegetables. Moreover, improved rainfall in the recent months would also contribute to moderation in the CPI which is expected to head lower in Q3 FY14 owing to positive base effects.

The Wholesale Price Index (WPI) came in lower at 5.19% for July 2014 as against 5.43% in June 2014 aided by decline in fuel prices. It may be noted that the weight of food and vegetable is lower in WPI index as against CPI index leading to contrarian movements in the inflation readings.

Index of Industrial Production (IIP) moderates but in positive territory

Industrial production slowed to 3.4% YoY in June 2014 as against market expectation of 5.6%. The slowdown was owing to contraction in consumer goods. Recent Purchasing Managers Index (PMI) data has remained healthy denoting an upward momentum in growth prospects.

India’s Current Account Deficit (CAD) widened to 1.7% of GDP for Q1-FY14 sequentially from 0.3% in Q4-FY13. However, it improved on yearly basis. Net capital inflows surged from 1.8% of GDP to 4.2% resulting in surplus in balance of payments.

The Reserve Bank of India (RBI) announced a liquidity framework which could reduce the volatility in the overnight rates. It may be noted that the overnight rates were subject to higher volatility in recent times owing to surging government cash balance. These measures would limit the volatility in overnight rates allowing for overnight rates to be closer to repo and term repo cut offs.

Going Forward

The RBI’s policy stance remains firmly anchored on keeping theeconomy on a disinflationary glide path of taking the CPI inflation to 8% by January 2015 and below 6% by January 2016.Monsoons in the near-term and its impact on food prices, and geo-political tensions and changes in US monetary policy remain key risk factors.The short term yields are likely to remain well anchored around the RBI operating overnight rate (Repo rate). There can be some pressure in the near-term on account of increase in certificate of deposit issuance by banks on rollover of maturities.The longer end of the G-sec yield curve is expected to see some easing due to subdued net supply of G-sec. We holding on to

long duration given the government’s commitment to maintain fiscal discipline and set targets.

The corporate bond yield curve is likely to steepen goingforward. The short term corporate bond yields are likely to benefit from stable overnight rates as well as increased demand from rollover of fixed maturity plans (FMPs). The long term yields are likely to see spreads between Government Securities (Gsec) and corporate bonds increase further, with a resumption in supply from the traditional issuers as well as new supply from banks (which have been incentivised to issue seven year maturity infrastructure bonds in the recent Union Budget).

We would increase duration on further market weakness primarily through G-sec position given our expectation of spreads to widen in Corporate bonds. We expect a rate cut cycle to begin in 2015 as inflation trends ease and supply side bottlenecks reduce due to government initiatives/policies.

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