Puneet Pal, Head Fixed Income, PGIM India Mutual Fund
The month of July 2024 saw bull steepening of the yield curve with the shorter segment (3-5 yrs) of the curve outperforming the rest of the curve. The 5 yr segment of the curve outperformed across the curve, as yields in the segment came down by 17 bps compared to the fall of 7 bps in the benchmark 10 yr bond yield which ended the month at a yield of 6.93%. The longer end of the curve (30-40 yrs) underperformed, as the yields remained flat. The bull steepening of the curve was triggered by two specific announcements in the Union Budget; first was the reduction in the T-bill borrowing amount for FY25, and second was the higher bond switch amount (financing the buyback of shorter maturity securities by issuing longer maturity securities), which increases the supply of longer duration securities. Towards the end of the month, RBI announced that the incremental new issuances of the 14 yr and the 30 yr government securities (G-secs) shall not be eligible for Fully Accessible Route (FAR) status, thus the bullish sentiment on the longer end of the curve got tempered down and the curve started steepening.
During the month, the Union Budget projected a fiscal deficit of 4.90%, lower than the 5.10% given in the Interim budget. Though the borrowings through dated government securities came down only by INR 120 bn owing to reduction in the amount of borrowing through T-bills, small savings and other receipts which has kept the share of market borrowings (G-secs) in financing the fiscal deficit at 72% compared to 70% in the interim budget. The gross and the net borrowings have been kept at INR 14.01 trn and INR 11.63 trn respectively. The consolidated fiscal deficit (center plus state) narrows to 7.70% of GDP, which is a 5 yr low. The budget assumes the growth in nominal GDP to be at 10.50%. Overall, the tax assumptions are conservative with tax revenue growth pegged at 10.80% and though the capex spend was kept unchanged the overall expenditure has been increased by INR 650 bn. Hence the increased head room from additional RBI dividend was uitlized almost equally to increase revenue expenditure and to cut fiscal deficit which is lower by INR 700 bn compared to the interim budget.
Monsoon picked up and till August 1, cumulative rainfall was 4.4% above the long-term average while weekly rainfall was 18% above the long-term average. On a cumulative basis, rainfall was excess in central India and southern India, normal in northern India, and deficient in east and north-east India. As of July end, out of the 36 sub-divisions, nine have received deficient rainfall, 14 have received normal rainfall, and 13 have received excess rainfall. As of August 1, the total kharif acreage was 2.9% higher than the same period last year, while rice sowing was annually higher by 5.3% higher 27.7 mn hectares. Oilseeds acreage was 3% higher at 18 mn hectares while pulses acreage at 11.1 mn hectares was 11% higher than last year. Coarse cereal acreage was 3.2% higher at 16.6 mn hectares. Sugarcane acreage was 1% higher at 5.8 mn hectares, and cotton acreage was 8.3% lower at 10.8 mn hectares. Basin-wise reservoir levels had moved to surplus. Among major river basins, Cauvery (south), Godavari (west and south), Krishna (west and south), Narmada (central and west), Tapi (central and west), and West flowing southern rivers were surplus. While Ganga (north and east), Indus (north India), and Mahanadi (central and east), were deficient. Basins and reservoirs levels were around 7% above the long-term average, but around 8% below last year levels for week-ending August 1.
Banking sector liquidity eased on back of higher government spending, however, short-term money market yields remained elevated due to skewed distribution of liquidity with 3-month maturity Bank CD's trading at 7.16%. The INR depreciated on back of weakness in Asian currencies even as FPI inflows remained positive with USD 2.67 bn of FPI inflows coming into debt after the first month of inclusion in the JP Morgan EM Index. INR ended the month at an all-time low of 83.73 per USD compared to last month's closing of 83.39.
The OIS curve moved lower in line with global bond yields with the 1 yr OIS down by 15 bps in July at 6.67%, while the 5 yr OIS was down by 22 bps ending the month at 6.22%.
Global bond yields also cooled off with the benchmark US 10 yr bond yield down by 37 bps on back of relatively softer economic data. BOJ hiked rates as expected by the markets.
Going ahead we believe that the RBI is likely to maintain status quo on policy rates in the ensuing MPC meeting on August 8. The rate cutting cycle in the developed markets has started in right earnest with the Bank of England cutting rates following the rate cuts from the ECB and the Bank of Canada. Given the current growth/ inflation dynamics and the wedge between the deposit and the credit growth rates which is nudging banks to increase their deposit rates, we believe that rate cuts in India are still some time away, and we believe that rate cuts in India will start from Q3/Q4 of FY25 onwards. Markets tend to react before the start of a rate cutting cycle and any retracement in yields from current levels offers a good opportunity to investors to increase their allocation to fixed income as real and nominal yields remain attractive with favourable demand supply dynamics playing out in the sovereign bond market. We expect the 10 yr benchmark bond yield to keep drifting lower gradually and converge with the policy repo rate before the start of the rate cutting cycle. |
