Liquidity surplus to remain range bound. The liquidity conditions marginally improved last week, averaging ~Rs 1.73 tn as against Rs 1.53 tn for the week ending Sep 22. Throughout the week, the liquidity surplus remained mostly unchanged. Overnight rates inched lower by ~9bps to 5.84%. We expect the liquidity surplus to improve in the start of this week on account of month-end government spending but to tighten towards the end of the week amidst monthly tax outflows and CIC increase.
Government's cash balance surge. Expectedly, the government has a huge surplus in its cash balance account on the back of advance tax collections along with auction related inflows amidst limited government spending. Notably, the government's fiscal deficit has hit 96.1% of the budgeted estimates until August, thereby ensuring minimal expenditure going ahead. We estimate that the government cash surplus may have surged to ~Rs 1.25 tn by end of September. However, the month-end government spending would have reduced this surplus to around Rs 900bn currently. The surplus may further increase by end of this week given the monthly tax inflows. Given the expected build up of cash balance, RBI has possibly reduced the WMA limit to Rs 250bn from Rs 600bn set in the previous quarter.
Currency in circulation begins to show seasonal patterns. After nearly 11 months of demonetisation, the currency in circulation (CIC) has finally started to show early signs of seasonality that existed before November 2016, even though not yet in full swing. CIC for the week ending Sep 22 fell by Rs 25.9bn to Rs 15.81tn. CIC is expected to have increased marginally in the previous week given the festive demand and then to further inch up in the current week. Further this month we expected festive related demand to increase the CIC pace significantly.
Rates and Macro Monitor
RBI to be 'cautiously neutral'. Factors like domestic inflation normalisation, risk of fiscal slippage, possible re-emergence of global reflationary theme and possibly tighter global financial conditions etc. will keep RBI somewhat cautious in the upcoming policy. We expect headline CPI inflation to inch higher as adverse base effect and 7CPC HRA impact begins to seep in, pushing the headline inflation towards 4% by November 2017 and 4.7% by March 2018 (4.3% without HRA). With RBI seemingly fixated on the 4% inflation target and on the direction of inflation going ahead, we expect the RBI to pause for the rest of FY2018. We remain watchful of the incoming data and reckon that room for any further cut can open up again if inflation surprises below the 4% mark on the back of (1) continued improvement in food supplies, (2) lagged imported disinflation due to INR appreciation in the past few months and (3) downward surprise of core inflation owing to weaker-than-expected growth.
Fiscal worries weigh on Gsec. Fiscal worries have been keeping bond market on its toes. Market traded most of the week negative owing to unconfirmed media reports that government is considering slipping on the fiscal target of 3.2% of GDP. Market keenly awaited the 2HFY18 borrowing calendar for any additional cues. However2HFY18 gross borrowing came as budgeted at Rs2.08 tn, even as government stated that it will assess the fiscal situation and may take a call on additional borrowing after December. Market initially heaved a brief sigh of relief, but sentiments again worsened on concerns that the government frontloaded the borrowing in 3QFY18 to create space for additional borrowing to the tune of Rs 1tn in the last quarter. The 10-year yield briefly hit a high of 6.70%. However, value buying in the quarter end provided some relief, with the benchmark 10-yr yield ending the week flat at ~6.66%. We have the RBI policy tomorrow which will set the tone for the rest of the week(s). We expect the benchmark 10-yr yield to trade in the range of 6.60-6.70% through the week.
Corporate bonds remain choppy. Corporate bonds traded on choppy note as sentiments got clouded by the fiscal uncertainty. Last week we saw issuances to the tune of approx. Rs. 5500 cr with REC ( Rs 1150 cr), Renew Akshay Urja (Rs 760 cr) being the notable ones.