Indian bond market: Liquidity remains the name of the game

In Focus: India Fixed Income For private circulation only Indian bond market: Liquidity remains the name of the game India 10Y yield remains volatile...
Author: Jodie Wheeler
0 downloads 2 Views 359KB Size
In Focus: India Fixed Income For private circulation only

Indian bond market: Liquidity remains the name of the game India 10Y yield remains volatile in face of demonetisation



Government’s demonetization remained key, pushing up systemic liquidity to above INR 5 tn and causing yields to fall sharply (in contrast to EM space that remained driven by US elections).



Reports of auction of securities under MSS and subsequent measures to introduce incremental CRR of 100% by RBI has caused yields to correct significantly (~15 bps since Friday).



The incremental CRR is likely to suck out INR 3.2 tn from the system and lead to a sharp fall in liquidity. Implications for monetary policy transmission will be watched closely.



We expect RBI to reduce rates by at least 25 bps in December. However, a deeper rate cut cannot be ruled out. The 10Y bond is expected to remain volatile in the coming months as clarity on impact of demonetization (and subsequent RBI/Govt. steps) is reached.

India benchmark 10Y yield

(%) 7.0 6.8

6.6 6.4 6.2

6.0

Source: Bloomberg, Research

ICICI

28-Nov-16

23-Nov-16

18-Nov-16

8-Nov-16

13-Nov-16

3-Nov-16

29-Oct-16

24-Oct-16

19-Oct-16

9-Oct-16

14-Oct-16

29-Sep-16

4-Oct-16

5.8

Bank

Indian bond market sees sharp correction… Systemic liquidity to see a sharp fall in coming days as banks adhere to new CRR norms Systemic Liquidity

(INR bn) 5,500 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 -500 -1,000

Surplus



 25-Nov-16

Source: RBI, ICICI Bank Research

18-Nov-16

4-Nov-16

11-Nov-16

28-Oct-16

21-Oct-16

14-Oct-16

7-Oct-16

30-Sep-16

23-Sep-16

16-Sep-16

Deficit 9-Sep-16

2-Sep-16



November 28, 2016

Government’s move to demonetise currency has resulted in a sharp surge in liquidity to above INR 5 tn currently. In tandem with this (and on expectation of easing by the RBI), yields plunged over 50 bps from 6.80% levels prior to demonetisation. o The move was opposite to the sell-off seen in the EM space as US Presidential elections dominated the global space. Thereon, the yield on the 10Y plunged below the repo to hit a low of 6.14% on Friday. However, as reports of Government issuing securities under Market Stabilisation Scheme (MSS) to check liquidity surfaced, a sharp correction was seen. Yields rose to close the week at 6.23%. An additional 10 bps rise in yields has been seen as RBI announced the incremental CRR for banks. The 10Y yield is currently hovering at 6.33% levels.

…as RBI introduces incremental CRR to address the liquidity spike RBI has stepped up its reverse repo operations lately to suck out additional systemic liquidity. To further address the issue of excess liquidity, RBI has announced an incremental CRR of 100% on the increase in NDTL between September 16, 2016 and November 11, 2016. This amounts to ~ INR 3.2 tn being removed from the system. Further, RBI Governor has stated that the Government will issue adequate quantum of bonds under MSS. What to watch out for?

Niharika Tripathi [email protected] +91-22- 40086943 Sumeet Agrawal [email protected] +91-22- 40087213 Please see important disclaimer at the end of this report

Given that banks will now park their additional deposits at the RBI, we expected liquidity to come-off sharply as banks adhere to the new rule. Further, lending rates were expected to go down given the surplus liquidity in the system and aid monetary policy transmission. This will now have to be watched closely. December rate cut on the cards 



Given the cooling in the inflation numbers and need to boost growth- all asks for further accommodation have been met. We maintain our call and expect the RBI to deliver at least a 25 bps rate cut in December. However, a deeper rate cut cannot be ruled out. The 10Y bond is expected to remain volatile in the coming months as clarity on impact of demonetization (and subsequent RBI/Govt. steps) is reached.

India Fixed Income

Global market movement dominated by Trump On November 9th, US voted to elect Donald Trump as its 45th President. What followed this decision was expectation of a fiscal stimulus and more aggressive interest rate tightening under the Trump administration, leading to expectation of higher inflation and growth in the US. Marked movement in financial markets was seen:  



The US 10Y yield moved above the 2% mark and DXY crossed the 100 threshold as market implied probability of a December rate hike approached 100%. In tandem with this, the developed market space witnessed bond yields rising as well. Emerging market space witnessed capital outflows worth ~USD 12 bn (debt and equity). Concerns over Trump’s policies (specifically possibility of increased protectionism) caused a sharp sell-off in bond markets. o Within Asia, countries such as Indonesia and Malaysia have one of the highest foreign ownership of sovereign bonds, at ~ 38% and ~36% respectively. That has meant the impact of the sell-off on these markets has been the most. Going ahead, we believe the sell-off in the EM space isn’t over yet. As the Fed takes on its normalisation process and President-elect Trump takes office (in Jan 2017), volatility is likely to continue. Clarity is expected to emerge as the new President’s policies (specifically on trade, immigration etc.) take shape next year.

EM space has recorded sharp outflows (~USD 12 bn) in the days following the US Presidential election result Capital flows in EMs

(USD bn) 0.0

Equity

Change in 10Y yield

Debt

-0.5 -1.0

-1.5 -2.0 Philippines

Brazil

Korea

Turkey

South Africa

Thailand

India

-2.5 Indonesia

India bond yields moved in stark contrast to EM peers as domestic triggers remained at the forefront

Figures show change till November 21st since November 9th Data isn’t available for debt for Korea, Brazil and Philippines Source: IIF, ICICI Bank Research

China Russia South Africa Hungary Argentina South Korea Taiwan Brazil Malaysia Turkey Indonesia Mexico India

(bps) -60

-10

40

90

140

Figures show change till November 25 since November 8 close th

th

Source: Bloomberg, ICICI Bank Research

Indian bond move- outlier in EM space

India benchmark 10Y yield

(%) 7.0 6.8

6.6 6.4 6.2

6.0

Source: Bloomberg, ICICI Bank Research

2

28-Nov-16

23-Nov-16

18-Nov-16

13-Nov-16

8-Nov-16

3-Nov-16

29-Oct-16

24-Oct-16

19-Oct-16

14-Oct-16

5.8 9-Oct-16



Yield on 10Y sees correction post incremental CRR announcement

4-Oct-16



Government’s move to demonetise currency has resulted in a sharp surge in liquidity to above INR 5 tn currently. In tandem with this (and on expectation of easing by the RBI), yields plunged over 50 bps from 6.80% levels prior to demonetisation. o The move was opposite to the sell-off seen in the EM space as US Presidential elections dominated the global space. Thereon, the yield on the 10Y plunged below the repo to hit a low of 6.14% on Friday. However, as reports of Government issuing securities under Market Stabilisation Scheme (MSS) to check liquidity surfaced, a sharp correction was seen. Yields rose to close the week at 6.23%. An additional 10 bps rise in yields has been seen as RBI announced the incremental CRR for banks. The 10Y yield is currently hovering at 6.33% levels.

29-Sep-16



India Fixed Income Banking system sees liquidity surge Given the move to demonetize, following key observations have been seen  Sharp fall in currency in circulation (CIC): In the week ended November 18th, CIC has fallen by INR 3.6 tn to INR 14.3 tn. CIC has seen a marked rise over the last fiscal year, rising by over INR 2 tn. This had remained a key leakage from the system.  Bank deposits have risen sharply: As currency leakage has reduced and money has been deposited at banks, deposits have risen sharply. Available data shows that aggregate deposits rose INR 1.3 tn in the fortnight ended November 11th. This is likely to have gone up further since then. Demand deposit growth has seen a sharp step up to 20.3% YoY from 11.6% YoY over the same period.  Systemic liquidity surged to above INR 4 tn: Given the flow of funds back into the banking system, systemic liquidity has spiked to over INR 5 tn levels currently from INR 80 bn at the start of November.  Market rates moved out of policy corridor: Money market rates failed to remain within the policy corridor. The call rate (although currently above the repo) had slipped below the repo rate (of 6.25%).  Treasury yields have seen volatile session: The 10Y yield has moved sharply lower with improved liquidity and increased expectation of a December rate cut by RBI boosting demand for gilts. The 10Y yield had slipped below the repo rate last week. Thereon, some rebound is being seen in the yield on RBI’s CRR announcement (See next section).

Data till week ending November 18th

Source: RBI, CEIC, ICICI Bank Research

Credit growth

11

10 9 8

Nov-16

Oct-16

Sep-16

Aug-16

Jul-16

Jun-16

May-16

Apr-16

Mar-16

Feb-16

Jan-16

7 Dec-15

Nov-16

-10

Sep-16

12.0

Jul-16

-5

May-16

13.0

Mar-16

0

Jan-16

14.0

Nov-15

5

Sep-15

15.0

Jul-15

10

May-15

16.0

Mar-15

15

Jan-15

20

17.0

Nov-14

18.0

Nov-15

25

Deposit growth

(% YoY) 12

Oct-15

Growth (RHS) (%YoY)

Sep-15

Currency in Circulation (CIC)

(INR tn) 19.0

Bank deposits have risen sharply as cash leakage dropped

Aug-15

Currency in circulation has fallen by a sharp INR 3.6 tn in the week ended November 18th

Data till fortnight ending November 11th Source: RBI, CEIC, ICICI Bank Research

Steps to address the liquidity spike

Given that liquidity has surged sharply, what measures has the RBI undertaken to manage this liquidity? RBI has stepped up its reverse repo operations to suck out additional systemic liquidity. As of November 25th, RBI used ~ INR 5.2 tn of its domestic bond holdings in reverse repo operations (fixed and variable). Given the limited size of domestic assets (~INR 7 tn) on RBI’s balance sheet and the scale of reverse repo required to suck out excess liquidity from the system, alternate policy tools are required.

3

25-Nov-16

18-Nov-16

11-Nov-16

4-Nov-16

28-Oct-16

21-Oct-16

14-Oct-16

7-Oct-16

30-Sep-16

23-Sep-16

16-Sep-16

9-Sep-16

2-Sep-16

The Central Bank, as of Friday, has relaxed norms – extending the set of securities it can use as collateral. Henceforth, oil bonds issued by the Government will qualify as eligible security for repo, reverse repo and marginal standing facility. That is RBI can use oil bonds to extract liquidity via its reverse repo window. Liquidity to see a sharp fall in coming days To further address the issue, RBI has announced Systemic Liquidity (INR bn) incremental CRR of 100%: The magnitude of surplus 5,500 5,000 liquidity available with the banking system is expected to 4,500 Surplus 4,000 increase further in the fortnights ahead. In view of this, it has 3,500 been decided to absorb a part of this surplus liquidity by 3,000 2,500 applying an incremental cash reserve ratio (CRR) as a purely 2,000 temporary measure: 1,500 1,000 o The CRR remains unchanged at 4% of outstanding net 500 demand and time liabilities (NDTL). 0 -500 o On the increase in NDTL between September 16, 2016 Deficit -1,000 and November 11, 2016, scheduled banks are required to maintain an incremental CRR of 100%. This amounts to ~ INR 3.2 tn being removed from the system. Consequently, liquidity is expected to sharply fall going ahead. Source: RBI, ICICI Bank Research

India Fixed Income

Additionally, RBI Governor stated that the Government will issue adequate quantum of bonds under the Market Stabilisation Scheme (MSS). The MSS ceiling currently stands at INR 300 bn for the current fiscal. However, addressing the current liquidity scenario would require raising this ceiling significantly. However, there are examples in the past, such as in 2007 when the over INR 1 tn of securities were issued under MSS. It is important to note that the current situation would warrant a much higher issuance in a much shorter time frame. Given the fact that durability of deposits in the system is not clear at present, hence we expect the duration of MSS bonds issued to be less than 6 months.

What to watch out for? Given that banks will now park their additional deposits at the RBI, we expected liquidity to come-off sharply as banks adhere to the new rule. Further, lending rates were expected to go down given the surplus liquidity in the system and aid monetary policy transmission. This will now have to be watched closely.

December rate cut on the cards 

Given the cooling in the inflation numbers and need to boost growth- all asks for further accommodation have been met. We maintain our call and expect the RBI to deliver at least a 25 bps rate cut in December. However, a deeper rate cut cannot be ruled out.  The 10Y bond is expected to remain volatile in the coming months as clarity on impact of demonetization (and subsequent RBI/Govt. steps) is reached. o Factors supporting further downside in yields include expectation of significant easing by RBI as inflation is expected to cool further. Factors likely to push yields higher include any step to check liquidity. o Domestic factors are expected to remain at the forefront as markets assess the impact of demonetization. o Global events such as the Italian referendum, OPEC meeting and the two upcoming Central Bank policy meetings (US Federal Reserve and European Central Bank) will be closely tracked.

4

India Fixed Income APPENDIX 1. EM bond market: Movement in 10Y yield (bps) Total 28-Nov 25-Nov 24-Nov 23-Nov 22-Nov 21-Nov 18-Nov 17-Nov 16-Nov 15-Nov 14-Nov 11-Nov 10-Nov 9-Nov 8-Nov

China 10.9 -0.6 0.9 0.2 -2.3 0 -1.7 0.5 0.5 3 -2.3 4.4 3.5 4.2 -0.5 1.1

India

Malaysia

-50.4 9.9 4.5 -9.2 -3 0.4 -12.4 1.1 -2.7 -8.8 -19 0 6.3 -0.7 -13.1 -3.7

73.2 1.8 0.6 7.2 -5.3 -3.3 -1.6 6.2 14.2 -1.9 8.9 14.5 19.1 11.3 1 0.5

South Czech South Indonesia Hungary Poland Russia Turkey Argentina Brazil Columbia Mexico Korea Republic Africa 41.6 132.7 6.7 34.1 48.8 39.5 73.5 38.1 78 15.1 111.5 21.7 -3.8 4 0 0 0 0 0 0 0 0 0 -16.8 -0.8 10.9 -1.9 -2.9 -5 7 3.5 -7 25.3 -4.8 -2.8 6.5 5.6 15.4 -0.5 -10.1 -5.4 0 -5.5 0 2.4 -17.3 3.7 4 -0.5 10.2 1.9 2 14.3 10 13 -5.8 -0.4 0 5.3 4.2 1.3 5 -2.5 -4.8 -3.1 1 5.5 3.1 -6.8 -0.5 11.1 -0.1 2 2.6 -1 -1.2 -15.4 -4 -1.5 -26.1 -17.6 8.5 0 -0.9 5.8 6.5 -1.3 3 3.9 0.5 8.5 0 6 2.8 16.5 -2.2 -2.9 0.8 0 1 6.3 -8.5 -3.5 0 13.4 -0.3 -11.1 -1.9 0 6 1.1 7 9.8 6 1.5 8.7 -36.7 -1.7 -1.9 -3.7 -4.1 -4.3 -3.8 -3.9 0.1 -12 -2 0.1 1.4 6.7 -12.8 -10.6 17.3 6 4.3 12.2 16.1 -4 21 11.6 20.9 0 8.3 2.3 11.1 41.3 0.1 6.8 1.4 23 14.5 44.7 8.5 28.8 19.9 14.4 16.1 12.5 7.8 15.9 17.4 19 8.5 0 42.5 0.6 37.8 16.1 -2.9 8.8 0.2 9.1 4.1 3.5 18.5 12.1 29.2 2.1 45.3 12.3 -2.6 7 2.3 0 4.3 -2 -8.5 -3.3 -10.1 -9.8 -7.8 -1.9

Cells in red indicate sell-off

Source: Bloomberg, ICICI Bank Reserach

2. RBI’s balance sheet RBI's Balance sheet (FY2016) Liabilities INR bn Assets Ban kin g Departmen t (BD) Capital 0.1 Notes, rupee coin, small coin Reserve Fund 65.0 Gold Coin and Bullion Other Reserves 2.2 Investments-Foreign-BD Deposits 5065.3 Investments-Domestic-BD Other Liabilities and Provisions 10220.4 Bills Purchased and Discounted Loans and Advances Investment in subsidiaries Other Assets

INR bn 0.1 662.2 6727.8 7022.9 0.0 520.4 23.2 396.3

Issu e Departmen t (ID) Notes issued

Total liabilities

Gold Coin and Bullion (as backing 17077.2 for Note issue) 729.1 Rupee coin 1.7 Investment-Foreign-ID 16335.9 Investment-Domestic-ID 10.5 Domestic Bills of Exchange and other Commercial 0.0 Papers 32430. 1 Total assets

32430. 1

As of November 25th, RBI used ~ INR 5.2 tn of its Domestic bond holdings in reverse repo operations (fixed and variable). Given the limited size of domestic assets (~INR 7 tn) on RBI’s balance sheet and the scale of reverse repo required to suck out excess liquidity, alternate policy tools are required.

3. Brief background on Market Stabilisation Scheme (MSS): MSS was launched in 2004. Bonds issued under MSS would have all the attributes of the existing dated securities. The bills and securities will be issued by way of auctions to be conducted by the Reserve Bank. o The bills and securities issued for the purpose of MSS would be matched by an equivalent cash balance held by the Government with the Reserve Bank. o Thus, the impact on revenue and fiscal deficits of the Government would be to the extent of interest payment on bills/securities outstanding under the MSS. The intention of introducing MSS is essentially to differentiate the liquidity absorption of a more enduring nature by way of sterilisation from the day-to-day normal liquidity management operations.

5

India Fixed Income ICICI Bank: ICICI Bank Towers, Bandra Kurla Complex, Mumbai- 400 051. Phone: (+91-22) 2653-1414 Treasury Research Group Economics Research Sunandan Chaudhuri Kamalika Das Samir Tripathi Niharika Tripathi Pradeep Goyal Sumedha Dasgupta Renuka Khadke

Senior Economist Economist Economist Economist Economist Economist Economist

(+91-22) 2653-7525 (+91-22) 2653-1414 (ext. 6280) (+91-22) 2653-7233 (+91-22) 2653-1414 (ext. 6943) (+91-22) 2653-1414 (ext. 6229) (+91-22) 2653-1414 (ext. 7243) (+91-22) 2653-1414 (ext. 8976)

[email protected] [email protected] [email protected] [email protected] [email protected] [email protected] [email protected]

Treasury Desks Treasury Sales Gsec Desk Interest Rate Derivatives Corporate Bonds

(+91-22) 2653-1076-80 (+91-22) 2653-1001-05 (+91-22) 2653-1011-15 (+91-22) 2653-7242

Currency Desk FX Derivatives Commodities Desk

(+91-22) 2652-3228-33 (+91-22) 2653-8941/43 (+91-22) 2653-1037-42

6

India Fixed Income Disclaimer Any information in this email should not be construed as an offer, invitation, solicitation, solution or advice of any kind to buy or sell any financial products or services offered by ICICI Bank, unless specifically stated so. ICICI Bank is not acting as your financial adviser or in a fiduciary capacity in respect of this proposed transaction with you unless otherwise expressly agreed by us in writing. Before entering into any transaction you should take steps to ensure that you understand the transaction and have made an independent assessment of the appropriateness of the transaction in the light of your own objectives and circumstances, including the possible risks and benefits of entering into such transaction. You may consider asking advice from your advisers in making this assessment. No part of this report may be copied or redistributed by any recipient for any purpose without ICICI’s prior written consent. Disclaimer for US/UK/Belgium residents This document is issued solely by ICICI Bank Limited (‘’ICICI’’). The material in this document is derived from sources ICICI believes to be reliable but which have not been independently verified. In preparing this document, ICICI has relied upon and assumed, the accuracy and completeness of all information available from public sources ICICI makes no guarantee of the accuracy and completeness of factual or analytical data and is not responsible for errors of transmission or reception. The opinions contained in such material constitute the judgment of ICICI in relation to the matters which are the subject of such material as at the date of its publication, all of which are expressed without any responsibility on ICICI’s part and are subject to change without notice. ICICI has no duty to update this document, the opinions, factual or analytical data contained herein. The information and opinions in such material are given by ICICI as part of its internal research activity and not as manager of or adviser in relation to any assets or investments and no consideration has been given to the particular needs of any recipient. Except for the historical information contained herein, statements in this document, which contain words or phrases such as 'will', 'would', etc., and similar expressions or variations of such expressions may constitute 'forward-looking statements'. These forward-looking statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially from those suggested by the forward-looking statements. ICICI Bank undertakes no obligation to update forward-looking statements to reflect events or circumstances after the date thereof. Nothing contained in this publication shall constitute or be deemed to constitute an offer to sell/purchase or as an invitation or solicitation to do so for any securities or financial products of any entity. ICICI Bank and/or its Affiliates, ("ICICI Group") make no representation as to the accuracy, completeness or reliability of any information contained herein or otherwise provided and hereby disclaim any liability with regard to the same. ICICI Group or its officers, employees, personnel, directors may be associated in a commercial or personal capacity or may have a commercial interest including as proprietary traders in or with the securities and/or companies or issues or matters as contained in this publication and such commercial capacity or interest whether or not differing with or conflicting with this publication, shall not make or render ICICI Group liable in any manner whatsoever & ICICI Group or any of its officers, employees, personnel, directors shall not be liable for any loss, damage, liability whatsoever for any direct or indirect loss arising from the use or access of any information that may be displayed in this publication from time to time. This document is intended for distribution solely to customers of ICICI. No part of this report may be copied or redistributed by any recipient for any purpose without ICICI’s prior written consent. If the reader of this message is not the intended recipient and has received this transmission in error, please immediately notify ICICI, Samir Tripathi , E-mail: [email protected] or by telephone at +91-22-2653-7233 and please delete this message from your system.

DISCLAIMER FOR DUBAI INTERNATIONAL FINANCIAL CENTRE (“DIFC”) CLIENTS: “This marketing material is distributed by ICICI Bank Ltd., Dubai International Financial Centre (DIFC) Branch and is intended only for ‘professional clients’ not retail clients. The financial products or financial services to which the marketing material relates to will only be made available to a ‘professional client’ as defined in the DFSA rule book via section COB 2.3.2. Professional clients as defined by DFSA need to have net assets of USD 500,000/- and have sufficient experience and understanding of relevant financial markets, products or transactions and any associated risks. The DIFC branch of ICICI Bank Ltd., is a duly licensed Category 1 Authorized Firm and regulated by the DFSA”. DISCLOSURE FOR RESIDENTS IN THE UNITED ARAB EMIRATES (“UAE”): This document is for personal use only and shall in no way be construed as a general offer for the sale of Products to the public in the UAE, or as an attempt to conduct business, as a financial institution or otherwise, in the UAE. Investors should note that any products mentioned in this document, any offering material related thereto and any interests therein have not been approved or licensed by the UAE Central Bank or by any other relevant licensing authority in the UAE, and they do not constitute a public offer of products in the UAE in accordance with the Commercial Companies Law, Federal Law No. 8 of 1984 (as amended) or otherwise.

7