Investment Update

FIXED INCOME OUTLOOK

Slew of policy measures undertaken by RBI to support the market

The Monetary Policy Committee (MPC) advanced its meeting by a week and announced a slew of measures to support the market by lowering key policy rates and infusing liquidity into the system last Friday March 27th 2020. MPC also decided to continue with the accommodative stance as long as it is necessary to revive growth and mitigate the impact of coronavirus (COVID-19) on the economy, while ensuring that inflation remains within the target level.

On the rate front, MPC implemented the following measures:

• Reduced the policy repo rate by 75 bps to 4.40% from 5.15%
• Marginal standing facility (MSF) rate and the Bank Rate stand reduced to 4.65% from 5.40%
• Reduced the reverse repo rate by 90 bps to 4.00% from 4.90%

 

On the liquidity front, MPC announced the following measures which would inject a total liquidity of INR3.74 lakh crores (USD 49.61 billion) or 3.2% of GDP in the system:

• Auctions of Targeted Long Term Repo Operations (TLTRO) of up to three years tenor of appropriate sizes for a total amount of up to INR 1 lakh crores (USD 13.26 billion) at a floating rate, linked to the policy repo rate. First auction of INR 25,000 crores (USD 3.32 billion) will be conducted today
• Liquidity availed through TLTRO by banks is to be deployed in investment grade corporate bonds, commercial paper and non-convertible debentures
• Investments made by banks under this facility will be classified as held to maturity (HTM) i.e. no mark to market Cash Reserve Ratio (CRR) cut by 100 bps to 3% for a year. This would release INR 1.37 lakh crores (USD 18.17 billion) uniformly.
• Increased the accommodation under Marginal Standing Facility to 3% of Statutory Liquidity Ratio (SLR) from 2% of SLR with immediate effect till June 30. This move would release an additional INR 1.37 lakh crores (USD 18.17 billion) in the system.

 

The following measures were announced to prevent the transmission of financial stress to the economy, ensuring the continuity of viable businesses and providing relief to borrowers:

• Moratorium of 3 months on payment of instalments in respect of all term loans
• Deferment of 3 months on payment of interest on Working Capital Facilities. The accumulated interest for the period will be paid after the expiry of the deferment period
• Net Stable Funding Ratio (NSFR) was to be introduced by banks in India from April 1, 2020
  is deferred by six months to October 1, 2020
• The implementation of the last tranche of 0.625% of the Capital Conservation Buffer (CCB) has been deferred from March 31, 2020 to September 30, 2020

 

In addition to above measures, RBI also took an important step of allowing Indian banks to participate in the offshore NDF market. This facility will be available for all the banks in India which operate International Financial Services Centre (IFSC) Banking Units (IBUs) with effect from June 1, 2020. Banks may participate through their branches in India, their foreign branches or through their IBUs.
MPC did not give any inflation and growth projections given the uncertainty surrounding intensity, spread and duration of COVID-19.

On the growth front, the governor highlighted that pandemic will have an impact on growth and if COVID-19 is prolonged and supply chain disruptions get accentuated, the global slowdown would deepen, which would have adverse implications for India. However, the slump in international crude prices could provide some relief in the form of terms of trade gains. Downside risks to growth has risen from the intensity, spread and duration of COVID-19 lockdowns. Upside growth impulses are expected to emanate from monetary, fiscal and other policy measures and the early containment of COVID-19.

On the inflation front, Governor mentioned that the prints for January and February 2020 indicate that actual outcomes for the quarter are running 30 bps above projections, reflecting the onion price shock.

Looking ahead, food prices may soften even further under the beneficial effects of the record food grains and horticulture production, at least till the onset of the usual summer uptick. Furthermore, the collapse in crude prices should work towards easing both fuel and core inflation pressures, depending on the level of the pass-through to retail prices. As a consequence of COVID-19 lockdown, aggregate demand may weaken and ease core inflation further. Heightened volatility in financial markets could also have a bearing on inflation.

On the borrowing front, the government had announced on the 31st of March its borrowing target for the year at 7.8 trillion rupees, while proposing to raise 62.5% of that amount (INR 4.88 trillion or USD 64 billion) in the first six months of the yearstarting April 1st. The amount is in line with the 60% – 62% that authorities usually raise in the first half of each fiscal year despite the large amounts of stimulus announced.

The first-half debt sales work out to 190-210 billion rupees a week, and the RBI won’t privately place debt with the Reserve Bank of India or Life Insurance Corp. of India. Bond buybacks and debt switches have been pencilled in at 2.7 trillion rupees (USD 35.82 billion) for the full year, while the so-called Ways and Means Advances have been set at 1.2 trillion
rupees (USD 15.92 billion) versus 750 billion rupees(USD 9.95 billion) in the April-September period of the previous fiscal.

In a move to encourage more foreigner ownership and to allow for more inclusion into international bond benchmarks, the RBI also announced that global funds will be able to buy new five-, 10- and 30-year bonds from April 1st. It removed caps on some issued debt including the benchmark and reserved the right to change or add tenors. Currently, foreigners hold just 2.7% of the 60 trillion rupees (USD 795.9 billion) of sovereign bonds issued by the RBI. The government had set a 6% limit on overseas ownership.

Under existing rules, foreigners can account for a maximum 30% of the outstanding amount of any sovereign security, and the combined upper limit will remain at 3.6 trillion rupees (USD 47.75 billion) until new limits are given by the RBI. The overseas cap in corporate debt will now be 15% of what’s outstanding.

Impact on the markets and our view

RBI is following global central banks in addressing the impact of COVID-19 on the economy and financial markets. The announcement comes at the time when the debt markets were showing extreme risk aversion due to the fact that the spreads at the shorter end of yield curve and on the credit side had soared by 100-300 bps in a few days, while the G-Secs continued to be see limited demand. In total, between the Finance Ministry and RBI, the stimulus package of INR 5.44 lakh crores (USD 72.16 billion) (fiscal stimulus of INR 1.70 lakh crores (USD 22.55 billion) and monetary stimulus of INR 3.74 lakh crores (USD 49.61 billion) has been announced to shore up the economy.

 

The following measures by the RBI signal an intent to preserve the financial stability of the markets, continuation of a soft interest rate bias and aggressive attempt to bring down yields at the shorter end of the curve:

By reducing the Reverse repo by 90 bps to 4.00%, it might be unattractive for the banks to park their surplus money with RBI.

• CRR cut would also infuse additional liquidity in the system. CRR cut combined with existing liquidity & low overnight rates would ensure the funding and borrowing needs of Corporates, MSMEs etc are met.
• Further, RBI has made it attractive for banks to invest in high quality corporate bonds by allowing them to classify their investments as Held till Maturity (HTM) i.e. there would be no MTM impact. This would allow the banks to earn decent carry since currently corporate bonds are at elevated levels.
• Due to the slowdown in economic scenario, there was fear in market participants that some corporates might default, the moratorium on term loans, deferment of payments on working capital and easing of working capital financing would provide some support and comfort to these corporates as such delays would not be treated as default.

 

By keeping benchmark rates low through the rate cut, widening of the LAF corridor and enhancing liquidity in the system through the combination of TLTRO, CRR and MSF, and not raising the amount of annual borrowings despite the large amount of stimulus announced, the yields of corporate debt securities which in recent days have been pressured on account of large selloff along with low trading activity, is expected to come down in the near future.

The central bank move of allowing Indian banks to participate in the offshore NDF market is expected to mitigate some of the volatility seen in USDINR movement in these turbulent times as this will enable RBI to intervene in offshore markets and the impact on Forex reserves will be lower than compared to intervention in onshore markets.

Going ahead we believe the local fixed income markets will focus on the auction demand in the weekly scheduled government bond auction of new H1 borrowing calendar announced yesterday, possibility of further OMOs from the RBI, any additional measures taken by global central banks in response to ongoing COVID-19 developments, movement in crude oil price which will accordingly determine the direction of the bond yields. Given the continuing uncertainty around the COVID-19 and its second round impact, markets may remain volatile in the near term though we expect the volatility to be much lower than what we have seen since February.

Reference rate as of 31st March at 1USD to 75.3859 used in all calculations.