Economic activity maintained its momentum in September as Covid-19 cases moderated and mobility increased. Fast pace of vaccination with almost 47% of adult population having taken one dose and 17% of population vaccinated with two doses (as on September end) also added confidence. Services PMI as well as manufacturing PMI remained in expansionary mode at 55.2 & 53.7 respectively indicating expansion in overall business conditions across the sector. August eight core sector output rose by 11.6% vs 9.4% for previous month as most of core industries except crude oil & fertilizer production witnessed y-o-y growth.
Headline CPI inflation for August surprised positively, easing to 5.30% y-o-y from 5.59% y-o-y in July and much lesser than the market expectations, primarily driven by moderation in food prices and favorable base effect. While prices of almost all food items declined during the last twelve months, the main drivers of lower food inflation were cereals and vegetables. Fuel & light inflation continue to impart pressure, in line with global crude prices. Core inflation, though still elevated, also eased to 5.89% y-o-y from 6.01%.
The September trade deficit further widened to a record high USD 22.9 bn from the previous month of USD 13.9 bn largely led by sharp rise in crude imports and as exports remained steady. Imports in September increased 84.7% y-o-y and 19.7% m-o-m while the September exports increased 21.3% y-o-y & remained flat on m-o-m basis. Sharp surge in crude import could have been led by the clearing of previously held up contracts due to lock-downs & inventory stock up by firms, and is likely to normalize. With the normalization in activity levels, FY2022 is again expected to slip in to trade deficit after recording a trade surplus in the previous year.
Foreign exchange reserves continue to surge and has reached a record high of USD 638.6 – up USD 5 bn for the month on the back of robust FPIs inflow and provides comfort on external stability. During the September month, both – equity as well as the debt segment witnessed healthy net FPI inflows of INR 8,348 cr & INR 10,246 cr respectively.
August GST revenues (collected in September) remained healthy at INR 1.17 lac cr & improved from the previous month INR 1.12 lac cr on the back of sustained economic momentum. Gross GST collections in 6mFY22 stood at INR 6.8 lac cr which is 50% higher than 6mFY21 and even ~13% higher than the pre-pandemic 6mFY20. Healthy gross tax revenues and moderate expenditure so far has helped in containing the fiscal deficit in 5mFY22 at ~31.1% of FY22 Budget Estimates. Central Government kept its 2HFY22 borrowing calendar unchanged at INR 5.03 lac cr (net borrowing of INR 3.78 lac cr) even after factoring the GST shortfall payout of INR 84,000 cr to States, which reflects comfortable fiscal situation.
Interest rates remained volatile in last month with upward bias as few of the large Central Banks indicated a higher likelihood of tapering of asset purchase program, sharp jump in crude oil prices and higher than expected 14 day VRRR cut-off in domestic market. Impact was largely felt in short end of the curve up-to 5 years, which hardened by 5-20 bps, while the longer end rallied by 2 – 5 bps. Corporate bonds under-performed the G-Sec in 1 to 4 years segment, which hardened by 15 – 35 bps and outperformed in the longer segment with a rally of 5 – 10 bps.
MPC in its October policy review decided to continue with its growth supportive stance by keeping policy rates unchanged and maintaining accommodative stance, for the consecutive eighth policy review. RBI maintained the GDP projection for FY22 at 9.5% while reduced the CPI projection by 40 bps to 5.3%.
Outlook
Amidst the continuing growth uncertainty, we feel that RBI will prioritize growth and will continue with its accommodative stance while keeping repo rates lower for longer. Recent moderation in headline inflation & expected further moderation in inflation over next few months will provide comfort to RBI to stay accommodative. However, imported inflation especially through higher crude prices can impart upward pressure and needs to be closely watched.
Within accommodative policy framework, we feel that RBI has taken a gradual approach towards the policy normalisation with the first initial step towards liquidity re-calibration amid massive built-up of surplus systemic liquidity which may be later followed by restoring of the policy rate corridor back to 25 bps (as before the pandemic) likely by early next year.
Against the backdrop of gradual normalization of policy rate corridor, we feel that upto 6 months segment of the yield curve is apt for risk-averse investors. For investors looking at the core allocation of their portfolio, the 2-5 years segment of the yield curve remains attractively placed from carry perspective given the current steepness of the curve. Additionally, recent hardening of interest rates, benign liquidity conditions and favorable demand-supply dynamics also augers well for this segment. This segment is neither too short to be adversely impacted by low yields nor too long to be exposed to high interest rate volatility amidst elevated fiscal supply. Investors with long term horizon & ability to absorb short term volatility may consider longer-end of the curve as a tactical allocation which finds merit on the back of conviction that RBI will manage the yield curve and may support the long-term yields through the tools like Open Market Purchase operations & Operation Twist.
While the credit environment is expected to improve over the medium term, we believe credit dispersion will continue as of now and one must be cautious when getting onto the credit side. Selective AA / AA+ rated credits backed by strong conviction of improvement on their credit metrics may provide favorable risk-reward opportunities.