Debt Market – June 2018

Macro Review
Inflation for the month of May came in at 4.87%, which was in line with market expectations though Core Inflation Inched higher to 6%, which is worrisome. The core CPI has been rising and is a cause for concern. Inflation will likely peak in the month of July when it is expected to come around 5.70-5.80%.

The trade deficit for the month of April came in at US$14.6 bn, highest in four months. It was led by higher Import growth in electronics, machinery and fertilisers. The current account deficit is expected to widen to 2.50-2.60% in FY19 from 2.00% in FY18.

Portfolio flows are also expected to moderate this year and coupled with the widening trade deficit, the overall BOP surplus is expected to come down significantly. Crude prices rose by 2.50% during the month even though OPEC decided to increase production but is factoring in lower spare capacity to any supply risk and driving up the prices.

Liquidity and Rates

Liquidity became comfortable at the end of the month as currency in circulation numbers stabilized and government spending rose. Overall liquidity is expected to become tight going ahead from a structural perspective as the current account deficit widens and portfolio flows slow down.

INR depreciated during the month even as RBI intervened in the currency market, INR depreciating by 1.58% last month. We continue to expect depreciation bias against INR on a widening current account deficit and also some incremental worsening in macroeconomic variables.

The yield curve continue to be flat on the sovereign side though going forward we do expect some steepness in the curve as potential higher supply in the belly of the curve and domestic /global uncertainty makes the longer end of the curve underperform.

The bond market, at the current yields, is factoring in incremental rate hikes of 25-50 bps in FY19 after the 25 bps hike in the June 2018 policy and we believe that at this juncture the behaviour of crude prices along with the evolving fiscal situation will be the most crucial variables in determining the stance of RBI.

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