Indian fixed income market
has a dull start in 2023 so far. Bond yields had been in a narrow range with the
10-year G-sec trading between 7.25%-7.35% for most part of the last two months
before closing the January month at 7.33%. On February 8, 2023, the 10 year
G-sec was at 7.34%
In the money market, yields
moved higher materially due to continued tightening in the liquidity condition.
A sustained wide gap between credit and deposit growth in the banking system
also contributed to rise in short term interest rates.
The 3 months treasury bill
yield moved up from 6.34% on Dec’22 to 6.48% by January end. It rose further in
the current month to 6.67% on February 8, 2023.
Certificate of deposits (CD)
rates of AAA rated PSU banks are currently around 7.20% for 3 months maturity
and around 7.60% for 1 year maturity. These rates were at 6.66% and 7.59%
respectively on December 30, 2022.
CPI inflation fell to 5.72%
YoY in December 2022. This was third consecutive monthly drop in the inflation
from its peak of 7.4% in September 2022.
A large part of
this disinflation was contributed by sharp decline in vegetables, which may
dissipate with the summer season uptick. However, inflation momentum measured
by month on month increase in index levels has come down significantly across
many goods and services.
Services inflation
overall has been muted and will likely remain benign due to weak employment
conditions and reduction in direct fiscal support for rural employment and farm
incomes.
We expect headline CPI
inflation to fall below 5% mark by mid of this year and average around 5.3% in
FY24.
In the Union budget for
FY24, the government managed to strike the fine
balance between boosting capital expenditure to stimulate growth and continuing
with the fiscal consolidation. The quality of government expenditure has
improved consistently in the last three years with capex to total expenditure
rising from 12% in FY21 to 22% in FY24. This should enhance future growth potential
of the economy and should lead to higher revenues for the government over
medium to long term.
The fiscal deficit for FY24
is set at 5.9% of GDP vs 6.4% in FY23. The Net and Gross market borrowing
estimates were raised marginally to Rs. 11.8 trillion and Rs. 15.4 trillion
respectively. However, this was slightly lower than broader market expectation.
Government also
reiterated its commitment to further consolidate its fiscal deficit to below
4.5% of GDP by FY 2025-26. Thus, market borrowings of the central government
should decrease or remain same for the next two years.
The monetary policy
committee of the RBI hiked the policy repo rate by 25 basis points in February meeting
by 4-2 vote and maintained the policy stance as “withdrawal of accommodation”.
The Repo rate now stands at
6.50%. Consequently, the Standing Deposit Facility (SDF) rate moved up to 6.25%
and Marginal Standing Facility (MSF) rate moved up to 6.75%.
The policy was
broadly in line with the market expectations though we were expecting a pause
in the rate hiking cycle this time.
The RBI seems
concerned about the sticky core Inflation while they are relatively more
comfortable on the growth outlook. The RBI estimates the CPI inflation to
average at 5.3% and real GDP growth at 6.4% in FY24.
In the last 10
months, the repo rate has been hiked by cumulative 250 basis points and the
short term money market rates have moved up by over 300 basis points. The full
impact of these measures is yet to be seen.
Based on the RBI’s
1 year ahead inflation estimate of 5.6%, the real repo rate is currently at 90
basis points and real rate on 1 year treasury bill is around 130 basis points.
In our opinion, the current real rates are adequate for the current state of
economic growth, and we would expect the RBI to pause the rate hiking cycle in
the next MPC meeting in April. We would expect the repo rate to remain at 6.50%
for the remainder of 2023.
Given the 25 basis
points rate hike was widely expected, there was limited impact on the bond market.
Bond yields moved up 3-5 basis points after the policy announcement. We
continue to expect the bond yields to go down over medium term with improvement
in external and fiscal balances and falling inflation.
Given the fact that a sizable rate hike has
already been delivered and the starting yields bonds are between 7.0%-7.5%,
bond funds are likely to do better over the coming 2-3 years. Investors with
2-3 years investment horizon and some appetite for intermittent volatility, can
continue to hold or add into dynamic bond funds.
Dynamic bond funds have
flexibility to change the portfolio positioning as per the evolving market
conditions. This makes dynamic bond funds better suited for the long-term
investors in this volatile macro environment.
Investors with shorter
investment horizon and low risk appetite should stick with liquid funds. Rate hike and continued reduction in durable liquidity surplus is
positive for short term debt fund categories like liquid fund. We would expect
further improvement in return potential of these categories as interest accrual
on short term debt instruments have risen meaningfully.
Since the interest rate on
bank saving accounts are not likely to increase quickly while the returns from
liquid fund are already seeing an increase, investing in liquid funds looks
more attractive for your surplus funds.
Investors with a short-term
investment horizon and with little desire to take risks, should invest in
liquid funds which own government securities and do not invest in private
sector companies which carry lower liquidity and higher risk of capital loss in
case of default.
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