The New Year started on a positive note with a successful launch of indigenous Covid-19 vaccination drive. India’s economic recovery continued to gather pace over last three months of calendar year 2020 and into 2021. Demand conditions remained buoyant across most sectors with activity levels almost close to pre-covid levels. The Indian economy in Q2 FY21 staged a strong recovery from the record decline of Q1, on back of resumption of economic activity.
GST collections for December rose to INR 1.15 lakh crore, the highest ever since the implementation of GST in July 2017. This is the fourth consecutive month this year that GST collections have outperformed yoy and is suggestive of recovery from the pandemic led disruptions. The collections were 11.6% higher yoy. However, April-December 2020 total GST collection amounted to INR 7.8 lakh crore, 14% lower yoy.
Retail inflation dropped sharply in December 2020 to 4.6% yoy and lower than the market expectations mainly on account of the seasonal easing of food prices viz. of vegetables & high base effect. Core inflation (excluding food and fuel) continued to be at elevated levels. Wholesale inflation declined to a four-month low of 1.2% in December 2020 aided by decline in the primary and fuel segments. There was, however, a sharp increase in price levels of the manufacturing segment on account of the rise in global metals prices.
The fiscal deficit in the first nine months of 2020-21 at INR 11.6 lakh crores saw a 24% yoy increase and is 145% of the budget estimate. December 2020 trade deficit widened to $15.71 billion from $9.8 billion in the previous month. This increase has been on account of a higher growth in imports.
In order to restore the normal liquidity management framework, RBI conducted a Variable Rate Reverse Term Repo Auction for Rs. 2 lac crs in January, which came sooner than expected. With this, short tenor rates upto 5 year quickly adjusted upwards by 40-50 bps and got anchored with the Reverse Repo Rate @ 3.35%.
Amidst the unprecedented economy disruption caused by the Pandemic, Finance Minister delivered a growth-oriented budget specifically targeted towards sectors like health, infrastructure and financials. While it will be a medium term positive, it has also resulted in a substantially higher fiscal deficit for FY21 / FY22 at 9.5% / 6.8% respectively with a fiscal gliding path to 4.5% by FY26. Quality of the fiscal deficit is better with higher spend towards the capex and with part of the food-subsidy taken on its own balance sheet.
In first week of February – RBI’s MPC(Monetary Policy Committee) kept the status quo on policy rates and continued its accommodative stance on policy rates as long as it is necessary, at least during the current financial year and into the next financial year, for growth revival on a durable basis, while ensuring that inflation remains within the target going forward.
Outlook
RBI’s MPC policy was setup against high expectations post the RBI’s liquidity measure & yet another year of record high Centre & State borrowings announced in the Central Budget. RBI delivered on liquidity stance by indicating continued ample systemic liquidity and also by delaying the restoring of CRR (Cash Reserve Ratio) by 2 months. However, the MPC fell short on the market expectations of providing visibility on its OMOs (Open Market Operations) for longer tenor G-Sec, although the Governor assured during the press conference that the FY22 G-Sec borrowing program will be completed in a smooth and a non-disruptive way.
In the absence of a concrete action from RBI on absorbing record high G-Sec supply, we expect the yield curve to steepen, going forward and the short term rates especially in 2 to 4 year segment to remain more attractive from risk-reward perspective on the back of surplus systemic liquidity and favorable demand-supply dynamics. While we believe that RBI may gradually reduce the excess liquidity in a market non-disruptive way, we expect RBI to continue to maintain surplus liquidity over the medium term to ensure conducive rate environment for borrowers to recover from Covid-19 led disruption.
Longer end of the curve will be more dependent on RBI’s OMOs both in terms of quantum and timeliness. Additionally, we believe global macro conditions with risk-on trade on hopes of Covid-19 vaccination and a benign global liquidity led by central banks have set the stage for a sustained outperformance of emerging market (EM) assets over the next few years. The expected weakening of the US dollar and the relatively higher accrual offered by Emerging Countries like India can create a strong Foreign Institutional Investors (FIIs) demand for domestic fixed income securities. Some allocation at the longer end finds merit on the back of conviction that RBI will manage the yield curve and FIIs demand may support the long-term yields.
Credit Environment has improved gradually with various measures taken by RBI and opening of economy now. We believe credit dispersion will continue, with very high-quality credits benefitting from this but the lower quality credits continuing to be avoided for the time being.