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Investment Insights

Suyash Choudhary

The RBI announced INR 40,000 crores of Open Market Operations (OMO) purchases for November, after having done INR 36,000 crores in October. Prior to this it had done INR 20,000 crores in September, and INR 10,000 crores monthly between May – July. This is largely in line with the two pillars of our core fixed income view: A shallow rate hike cycle; and large scale OMO purchases to partly compensate for an aggressive core liquidity deficit expected in the current financial year. The following points need reiteration given the OMO announcement and other goings-on recently:

 

1. There seems to have been more aggressive intervention from RBI in the forex market in October. This has correspondingly increased the projection on core deficit calculation and by implication for OMOs. By our estimate, core liquidity is still deficit approximately INR 50,000 crores as at date. Thus the OMOs announced for November will still largely only suffice to neutralize the current deficit without plugging any of the future leakage. Going by currency in circulation (CIC) trends just pre-demonetization and adding some nominal growth to it, one is looking at another approximately INR 175,000 crores currency leakage from here to March. Therefore, one should expect a steady pace of OMOs to continue over the rest of the financial year, even assuming that the RBI ultimately chooses to keep core liquidity in some deficit. If new sources of liquidity (forex via NRI deposit for instance) or new tools (long term repo, although ineffective in our view since this liquidity deficit is of a permanent and not temporary nature) come about, then the quantum of OMOs can be lesser. Reflecting the different demand – supply dynamics for government bonds owing to OMOs, as well as recent preference for liquidity, spreads on AAA quality bonds have risen to almost 100 bps over equivalent government bonds at parts of the yield curve.
 

2. Our view for some time has been that peak growth is past us. This view has largely been owing to the synchronized global recovery theme breaking down this year with consequent slowdown in export cycles, as well as due to a rapid tightening in local financial conditions.  The tightening in financial conditions will get further accentuated with the recent wobble in NBFC / HFCs. This incremental tightening in financial conditions is owing to rise in credit spreads and possible liquidity hoarding, even as quality rates have rallied and rupee has been more stable. These new developments may have further repercussions on growth as there may be some slowdown in aggregate lending, even if banks step in to compensate for slowdown in disbursements from NBFC / HFCs. For MPC, this implies that their current assessment that output gap has closed may change down the line. This may impart more patience even if food prices start rising from their current unsustainably low levels. For RBI, this means further efforts in pushing against excessively tight financial conditions. From a market standpoint, both these imply that an overweight stance on quality assets at the front end (sovereign / AAA up to 5 years) continues to make a lot of sense.
 
3. Fiscal risks are becoming significant with a continued shortfall in GST collections, and on possible overflows on expenditure items like fuel subsidy. Also, capital receipts need to get off the ground meaningfully, and face additional headwinds owing to a potential weaker capital market. Slowing growth may also impact tax collections down the line. All told, there is risk of almost a 0.5% of GDP on the fiscal deficit target. However, there are two distinctions to be made here: One, a ‘cash accounting’ budget allows for some ‘compression’ in deficit by delaying spending and up-fronting collection of some receivables. Hence, it is entirely possible that most of this potential slippage doesn’t feed into actual slippage. Two, even if there is some minor slippage acknowledged it may not necessarily translate into extra borrowing in dated government bonds and may get absorbed into other sources of financing including short term instruments, cash drawdown, or accretion from small savings.  For now, it is enough to acknowledge this risk (and hence restrict exposures to front end and not chase long duration, save tactically if at all), and be aware that if growth were to slow or bond yields to fall meaningfully, the temptation to admit to the slippage may be that much more.

 

Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency about the investment strategy / theme of the Scheme and should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. The information/ views / opinions provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision and the stocks may or may not continue to form part of the scheme’s portfolio in future. The decision of the Investment Manager may not always be profitable; as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. Neither IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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Suyash Choudhary

The Monetary Policy Committee (MPC) surprised market expectations by keeping policy rates on hold by a vote of 5:1. The member voting for the hike was external member Ghate. Notably, even the most hawkish RBI member, Patra, didn’t vote for a hike. The stance has been changed from ‘neutral’ to ‘calibrated tightening’. Again, the vote on stance change was 5:1, with one external member Dholakia voting to keep the stance unchanged.

 

Key points are as follows:

 
1. On Consumer Price Index (CPI), MPC acknowledged that ‘food inflation has remained unusually benign, which imparts a downward bias to its trajectory in the second half of the year’.  The risk to food inflation from spatially and temporally uneven rainfall is also mitigated, as confirmed in the first advance estimates for production. The Reserve Bank of India (RBI) has taken into consideration increase in Minimum Support Price (MSP), the USD 13 per barrel rise in India crude basket since last policy, the currency depreciation, and the impact of HRA from Pay Commission. After all of this, CPI is projected at 4% (4.6% estimated in previous policy) Q2 FY19, 3.9 – 4.5% (4.8%) in H2, and 4.8% (5%) in Q1, FY 20. Excluding HRA, CPI is projected at 3.7% (4.4%) in Q2 FY19, 3.8 – 4.5% (4.7% – 4.8%) in H2, and 4.8% (5%) in Q1 FY 20. Risks have been changed from balanced to ‘somewhat to the upside’.

 
2. GDP outlook is being aided by robust private consumption, although the rise in oil prices may impact disposable incomes. Improved capacity utilization, larger Foreign Direct Investment (FDI) flows, and increased financial resources to the corporate sector augur well for investment activity. However, the tightening in local and global financial conditions may dampen investment activity. Export outlook is uncertain as tailwinds from recent rupee depreciation could be muted by slowing of global trade and the escalating tariff war. Basis these, GDP growth projection for current year is retained at 7.4%, while Q1 FY 20 has been cut by 0.1% to 7.4%. Risks here are broadly balanced.
 
3. A Voluntary Retention Route (VRR) has been introduced for foreign portfolio investors (FPIs) where they need to voluntarily commit to retain in India a minimum required percentage of their investments for a period of their choice. FPIs would apply for investment limits under the Route through an auction process. Under this, they will have more operational flexibility in terms of instrument choices as well as exemptions from regulatory provisions such as the cap on short-term investments (less than one year) at 20% of portfolio size, concentration limits, and caps on exposure to a corporate group (20% of portfolio size and 50% of a single issue).
 

Takeaways

 
The policy today is very consistent with our core view as expressed in recent communications (please refer “Too Tight? A Market Update,” dated 24th September for details). We had said there “in our view, one should expect less and not more hawkish outcomes of policy relative to expectations. Hence, it is very likely that market is overpricing future policy hawkishness (on liquidity and rates) especially in light of recent events”. Since then the RBI has surprised markets in proactive liquidity steps (Liquidity Coverage Ratio (LCR) dispensation, Open Market Operations (OMOs)) and today surprised on rates as well.

 

The RBI / MPC action has to be looked at in two ways: One, this recognizes that substantial financial tightening is already underway and this doesn’t need additional help from policy. Two, it pushes against the notion that an interest rate defense is required for currency. We have argued against the interest rate defense logic previously (please refer our note “Back to Bedlam? A Bond & Macro Update”, dated 6th September for details). The starting point of real interest rates is much different than 2013 and an interest rate defense now is possibly a rethink on the whole CPI targeting framework. The Governor made it abundantly clear that RBI doesn’t take a view on the level of a rupee and only curbs volatility; and that interest rates will respond to the anticipated impact on CPI of currency depreciation, as any credible CPI targeting mandate should.
 

Finally, the commitment to provision of adequate liquidity has been reiterated including the provision of adequate reserve money to meet the economy’s demand.
 

Conclusions

 

A rate pause today doesn’t mean that the rate cycle is done. Given extreme uncertainty on currency and oil, there is still a possibility that upside risks indeed materialize. It is for this reason that stance has been changed; to indicated readiness to respond if required and to convey that there is absolutely no chance of a cut in the foreseeable future. We also retain an expectation of up to 2 hikes by the end of the financial year as of now. Even with that, and accounting for the INR 1,00,000 crore plus OMOs that we expect till March, front end rates are looking quite attractive. Preference, as expressed before, runs from sovereign to AAA with an explicit reiteration of caution here for lower rated / high yield strategies; given the rapidly deteriorating financing environment.

 

Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency about the investment strategy / theme of the Scheme and should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. The information/ views / opinions provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision and the stocks may or may not continue to form part of the scheme’s portfolio in future. The decision of the Investment Manager may not always be profitable; as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. Neither IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.>

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Suyash Choudhary

RBI Announces OMO Calendar

By: Punam Sharma

The RBI has announced an indicative (Open Market Operations) OMO calendar for INR 36,000 crores for the month of October. This has been done “on an assessment of the durable liquidity needs going forward and the seasonal growth in currency in circulation observed in build-up to the festive season”. This announcement is consistent with our general view that RBI is likely to be less hawkish than market expectation given the aggressive tightening in financial conditions lately (please refer “Too Tight? A Market Update”, dated 24th September for details https://www.idfcmf.com/insights/too-tight-a-market-update/ ); although the announcement of an actual calendar is a positive surprise. This measure had been preceded by dispensations given on Liquidity Coverage Ratio (LCR).

 

The other positive development lately has been announcement of the second half government borrowing calendar. After a INR 50,000 crores surprise cut to the full calendar when announcing the first half borrowing, the government has delivered an additional INR 20,000 crores cut to the second half calendar. Thus versus the budget announcement, the government will now borrow INR 70,000 crores lesser. Not just this, state borrowings have also been surprising on the lower side thus far. Thus states have borrowed INR 1,00,000 crores lesser than indicative calendar in the financial year so far. The Q3 calendar announced is also not particularly heavy at around INR 1,25,000 crores. Assuming this gets fully issued for a change, and accounting for a larger Q4 calendar, borrowings are looking similar to last year, especially on a net basis. If true, this is a far cry from the general concerns expressed thus far with respect to state finances.

 
Implications:
 
1. With a combination of liquidity measures taken so far, it is likely that market discounting of future rate comes off. The RBI policy at the end of the week will play an important role in this as well. Irrespective, the liquidity measures themselves have served to stabilize front end rates somewhat. Thus while ‘busy season’ effects will still be in play as credit to deposit ratio spikes, the rise in yields may now be more contained than previously thought.
 
2. Accounting for expected OMOs, the net supply on government bonds is only around INR 75,000 crores till March. Whereas, as described above, states have at least as yet not played spoilsport. This argues for term premia on government bonds to stabilize from here on, at least on bond supply considerations. The other input into current term premia is expectation of future repo rate. One will get further clarity on this with RBI policy at the end of the week. Our base case is of two more rate hikes till end of the year, versus three plus that market was discounting until very recently. Risk to the view, as before, is from a further appreciable rise in oil or weakness in INR.
 

Conclusions

 

The RBI moves so far have been consistent with our view that it makes sense to push against excess financial tightening in the interest of financial stability and to not unnecessarily jeopardize future growth. It continues to make sense to play this theme via quality front end assets, sovereign and AAA, in up to 5 year segment for the most part.

 

Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency about the investment strategy / theme of the Scheme and should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. The information/ views / opinions provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision and the stocks may or may not continue to form part of the scheme’s portfolio in future. The decision of the Investment Manager may not always be profitable; as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. Neither IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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