Inflation, Policy Expectation and Debt Market Opportunities

  • The latest Wholesale Price Index (WPI) inflation came at 14.55% for March 2022. This is up from 13.11% measured in February 2022. In the similar period, the Consumer Price Index (CPI) inflation for March 2022 was around 6.95%, which is a 17-month high. The domestic fuel prices were up by 34.5% year on year basis in March. These numbers are increasingly indicating that inflation in international energy prices is beginning to show its impact into domestic economy. RBI has made a base assumption of around US$ 100 per barrel in its inflation forecast. From that angle, the present oil price is trending well above the comfort zone.
  • For one, the inflation numbers are well above the Reserve Bank India (RBI) inflation target threshold of 4% - plus or minus 2%. With CPI trending up, to catch with the WPI inflation, the headroom for RBI seems to increasingly limited.
  • The Brent crude prices continue to remain elevated at around US$ 111 per barrel (as on 19th April 2022). This while very high, is still a relief from the US$ 123 p/b level seen in early March. These high oil prices are translating into high trade deficit for India due to rising oil import bill. For March-22 month, the oil import deficit was at around US$ 11 bn, alone. It is expected that the current account deficit could widen to 2.6 percent of GDP in 2022-23 from 1.7 percent of GDP in 2021-22. Already, the Indian Rupee is at 76 per US dollar and is trading well near its historical low against the greenback.
  • This will inevitably cast inflation pressure on domestic prices and also prompt weakening of the Rupee. RBI may therefore be increasingly inclined to reverse the rate trend and climb the rate hike ladder. Bond prices have already fallen in fear of sharp reversion in rates. The 10-year Indian gilt yields have hardened up from 6.67% in mid-February to 7.15% currently. In other words, the yields have hardened by 48 bps in the benchmark maturity. Market pundits are anticipating a rate hike of anywhere between 50-100 bps in the current year. Globally, central banks led by US Fed have already begun this process.
  • From the policy point of view, the buoyant tax and revenue collection provides some headroom for policy modulation. The GST collections continue to remain buoyant at around Rs 1.42 lakh cr. Moreover, the direct tax collections have soared by 48% in FY22. Net collections of direct taxes until March 16, 2022, FY22, stood at Rs 13.63 trillion compared to Rs 9.18 trillion in the same period last year. This tax collection trend is expected to continue in FY23. This provides some silver lining for that Indian policy makers. Our Forex reserves at US$ 604 bn also acts as a strong bulwark against these global tides. This provides RBI more flexibility to use additional policy tools to manage inflation impact and balance growth.
  • From bond market view point, there is currently a spread of 300-350 bps between overnight money market rates and the 10-year gilt. This wide spread seems to have overpriced a very hawkish stance than what RBI may actually adopt. Having said that, the borrowing calendar by RBI very aggressive. Of the total gross borrowing of around Rs14.3 lakh cr in FY23, around 8.45 lakh cr is planned for H1-FY23. This may cast a severe constraint on the market liquidity and further harden yield curve. With rising inflation, and impending rate hike cycle, intermittent bouts of high volatility in the debt market are likely possible. So the market will keenly observe future data before making conclusions.
  • From that stand point, we believe that select buying opportunities for risk-savvy investors may emerge in the medium-to-long term investors. RBI has not completely moved away from its growth orientation; therefore, the pace of rate hikes may be less aggressive that what market anticipates.
  • From investment standpoint, risk averse investors may consider target maturity funds to capture the present yield levels to tide over the market volatility. SDL spreads are already quite attractive at current juncture. With allocation in target maturity funds, the investor is likely to capture the present yield and also benefit from indexation gains (if the holding period is 3 years or more). Short term investors can consider parking their assets in money market/ ultra-short-term debt funds and make opportunistic STPs from that vantage point in the times to come.

Source :, , Bloomberg
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