Bonds held up well

India’s bond markets have held up well compared to the currency and equity markets. The banknote reform has pushed up deposit growth, which in turn has boosted liquidity, says the Development Bank of Singapore (DBS).

With credit growth still weak, excess liquidity has pushed Indian ten-year bond yields sharply lower this week. This is in contrast to Asian price action. Markets’ based borrowing rates and banks’ lending rates are also softening.

Alongside the liquidity boost, the banknote reform is expected to depress inflationary pressures. This is addition to the already positive inflation trend. Oct 2016 inflation eased to 4.2% YoY from a peak of 6.1% in Jul 2016, said DBS in its daily report on Nov 17, 2016.

Easing food inflation was the main drag, in turn entirely due to a sharp fall in vegetables and pulses, while other segments were little changed.

Core CPI inflation (ex-food and fuel) has been fairly steady in the 4.5-5.0% range for nearly a year. In light of a normal monsoon, smaller rise in minimum support prices and administrative steps undertaken by the government, food inflation is likely to stay below 5% this year, it said.

Global crude prices are up since the nadir in Jan, but have struggled to gain ground on an uncertain supply outlook.

From the demand end, the recent banknote reform is likely to hurt consumption. This, to some extent, will offset the lift from higher public sector wages, posing downside risks to our inflation estimate of 4.8% for the year, according to the bank.

The positive inflation path and Reserve Bank of India’s lower real rate threshold, along with their noncommittal to the 4% inflation target for FY17/18 leaves the room for a 25bp cut in 1Q17. Contingent on the inflation outlook, odds for another 25bp cut within 1H17 will also rise.

A cut in the December meeting, however, looks unlikely after the pre-emptive rate cut in October and volatile financial markets amidst rising external uncertainties.

INR tumbled to a five-month low on Nov 16, 2016, within striking distance of the 68 handle, while equities struggle to retain gains.

Until the currency crunch is resolved, more payments are likely to be settled through electronic modes of payments, plastic money and ewallets, amongst others, believes the bank. fii-news.com