The year gone by one of glorious uncertainties and low visibility, both globally and domestically. Fear of euro-zone breakup, tepid US growth and Japanese recession made headlines. Emerging market growth forecasts came down in tandem. Central banks in advanced economies as well as many of the emerging economies continued with easy policy bias to boost growth. Even with slow global growth, oil prices spiked at the start of the year on geo-political risks, while other commodity prices remained soft.
Internally, the macro environment remained challenging. India’s official growth estimate for FY13 was lowered to around 5.8% from initial Budget estimates of 7.6%. Inflation that came down from very high levels of last year remained stubbornly sticky around 7.5%. High twin deficits and tepid growth put the currency under pressure.
The RBI refrained from cutting rates after April and, yet, exhibited an easing bias through various liquidity measures. Liquidity in the system that had eased within RBI’s comfort level due to OMOs and CRR cuts, started tightening November onwards on low government spending, wedge between deposit and credit growth, and high currency leakages. Advance Tax payments in December further worsened the overall liquidity position, though it’s likely to improve next quarter based on RBI’s efforts.
Meeting the fiscal deficit target of 5.3% of GDP seems challenging with lower revenue collections and higher subsidy expenditure.
However, sentiment has improved since mid-Sept as the government initiated reform initiatives — hiked diesel price, raised FDI limits and started financial restructuring of the power sector. The Winter session of Parliament delivered — FDI in multi-brand retail, Companies Bill and Banking Bill were passed. The reform momentum gained as the government increased the cap on FII investment on both government securities and corporate debt by $5 billion each, cleared urea investment policy, and cleared setting up of a Cabinet Committee on Investment, which will fast-track approval to projects of over R1,000 crore. Direct cash transfer, considered a game changer, is also expected soon. These policy initiatives and reforms have helped boost sentiment.
The 10-year benchmark did touch a high of 8.7% in April as sentiment was hurt by considerable fiscal slippage in FY12 and announcement of higher borrowing in the first half of the fiscal. But RBI’s OMO support, lower growth numbers, reform initiatives, and global risk aversions kept the benchmark yield around 8.2%. Easing liquidity conditions helped the shorter end of the yield curve.
Better outlook in 2013
Growth is expected to bottom out and improve next year as reform initiatives and better sentiments translate to higher activity levels. Inflation numbers have already come in below projected levels for the past two months. Next year, inflation is expected to come down further — the lowest in three years. RBI has indicated a shift in stance to support growth and, finally, rates amy move down. Fiscal deficit target is obviously very challenging to achieve, but it is encouraging to see that government is serious about cutting expenditure. If the fiscal deficit approximates 5.3%, market is well positioned to absorb any additional supply based on banks’ additional SLR demand, RBI’s OMOs, & demand from FIIs, MFs, pension and insurance funds. Further the government seems intent to remain on the path of fiscal consolidation even in FY14 despite that being an election year.
Going into 2013, the bond market will find support from falling inflation, moderate growth trends, manageable twin deficits and monetary easing measures. The demand-supply dynamics will remain favorable and RBI might cut repo rate by 50-75 basis points in next 3-6 months. Bond yields are expected to move down meaningfully. We expect the curve to bull steepen over the next 12 months, thus presenting investment opportunities across the yield curve.
The author is head of fixed income, Reliance Capital Asset Management