WPI Inflation for June is below 5 %, GDP growth is at a decade low of 4.8% and IIP for May is at -1.3%. In this scenario, normally the Reserve Bank of India (RBI) might have chosen to cut the rates. But the RBI`s chose to focus on currency stability above inflation risks and growth slowdown. This resulted in spike in the overnight rate & short term instruments by 200 -300 bps.
Current Account & Trade Deficit:
India's trade deficit in June narrowed from the previous month as imports of gold fell in response to number of measures taken by the government and the central bank, the deficit narrowed to $12.2 billion from $20.1 billion in May.
The data show imports of gold and silver in June fell 70% from May to $2.45 billion. Crude oil imports also fell to $12.7 billion from $15 billion in May. The fall in gold imports helped slow growth in India's overall imports. Total imports in June fell to $36.03 billion from $44.65 billion in May.
India’s Current Account Deficit is expected to be around 80-90 billion USD, out of which 50-55 billion USD is expected to be funded through NRI Remittances and other flows while the remaining 20-25 billion USD is expected from capital market flows (equity and debt flows from FII’s).
Due to US Fed's announcement that it might taper quantitative easing, we have seen massive outflow from debt markets all over the world. FIIs sold debt of Rs 32,336 crore in June. With India needing to fund current account deficit through inflows the outflows in debt funds, aggravated the situation which led to the sharp depreciation of INR against Dollar.(Source: Bloomberg, July 2013)
US 10 Year Yield V/s India 10 year yield
Treasury yields in the US have crossed 2.5%, adding a further sell off from Indian debt markets. The difference in yields between the US 10-year treasury and the Indian 10-year G-sec has reduced from 6.24% seen in Jan-13 to 5.59% in Jul-13. Even though Indian debt yields are higher than in other emerging markets but the high returns might not be attractive enough against a falling rupee. The biggest factor which has driven away FII has been the volatility in currency.
Source: Bloomberg, 6th August 2013
Instead of hiking rates directly, the RBI increased the MSF by 200 bps to 10.25% on 15th July; the LAF limit for each bank was set at Rs. 75,000 crores. RBI also has restricted the aggregate limit for repo borrowings under liquidity adjustment facility (LAF) by individual banks to 0.5% of its own deposits (NDTL) effective from 24 July 2013. Further, banks will now have to maintain a higher CRR on an average daily basis in a reporting fortnight. The average daily CRR requirement now stands increased from 70% to 99% effective from 27th July. These measures are expected to choke the liquidity significantly and reduce currency speculation.
RBI feels the high interest rates and increasing differential with US Treasuries again will start getting FII flows in debt market.
Impact on interest rates:
Interest rates, especially short terms rates will be under upward pressure as RBI delivered a double blow in form of sharply lower LAF funding limit and higher CRR requirement. The overnight rates will move towards the MSF rate which is currently at 10.25% as banks will meet their funding requirement from the MSF window. In view of reduced borrowing limits, banks may sell their Statutory G-sec (SLR) holdings, which shall put further upward pressure on the G-sec yields and the curve is expected to move upwards.
Source: Bloomberg, 2nd August 2013
Source: Data for article are sourced from financial websites and Bloomberg.
We will explain Credit Risks and its impact on Debt Markets in the next edition on Mirae Asset Knowledge Academy Tutorials.
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