Liquidity surplus to tighten marginally - Money Market View - Kotak

Liquidity surplus improved last week. The weekly average surplus improved at ~Rs 3.6 tn for the week ending Jun 3 compared to Rs 3.3 tn for the week ending May 26. After having dipped to the week's low of Rs 3.21tn in the middle of the past week, the liquidity surplus increased sharply by ~Rs 860 bn to end the week at ~Rs 4.08 tn, led largely by government spending. Meanwhile, the government continued to utilize the WMA to the tune of of Rs 349bn as on May 26, similar levels as last week. The continuation of cash shortfall has been prompting RBI to issue more CMBs. After a 77-day CMB issuance last week, RBI has again conducted a 63-day CMB issuance to the tune of Rs 300bn today. The government seems to be frontloading expenditure and spending aggressively to send the fiscal impulse rolling through rest of the year. Given the tenor of the CMB, it is possible that the shortfall in cash balances maybe continuing at least through the advance tax time and beyond. Meanwhile, the average overnight funding rates for the week inched higher by about 20bps to 6.07%.

Pace of weekly increase in currency in circulation falls sharply. While maintaining the uptrend, the pace of weekly increase in currency in circulation (CIC) seems to be settling at a significantly lower pace. CIC for the week ending May 26 increased by mere Rs 59 bn to Rs 14.88 tn, compared to the CY2017 weekly average of Rs 300bn. This now roughly forms around 9.98% of nominal GDP compared to ~12% prior to demonetization.

Liquidity conditions to tighten marginally. With government expected to garner revenues from excise and customs, regular Gsec auction and CMBs, WMA issuances amount could reduce, implying marginally tighten liquidity. However, given recent frontloaded government spending pattern, we expect the liquidity surplus to remain well floored comfortably above Rs 3 tn. But if the government prefers to spend all the inflows rather than paying back to RBI then surplus is further likely to improve.

Rates and Macro Monitor

Bonds cheer the weaker growth; all eyes on policy. The G-sec market started the past week sideways and moved marginally lower in early part of the week. But the market sentiments improved significantly post the weaker-than expected GDP report, which reinstated weaker growth outlook. The softening bias of UST 10-yr yield and weak crude prices helped further at the margin. The benchmark 10-yr paper yield eased 2.5bps WoW. This week has started sideways, despite weaker global yields, as domestic markets enter the policy week. There is hope that RBI policy tone will soften owing to weaker inflation and growth prints. We expect the benchmark 10-yr paper to trade in the range of 6.55-6.65% assuming some softness in RBI's tone. However in case RBI continues with its cautious/hawkish rhetoric, we will see sell-off in bonds, and the 10-yr paper could then trade in the range of 6.60-6.70%. Besides this, we have key global events this week that markets will keep a watch on: the ECB policy, UK elections, James Comey's testimony about Trump's confrontation.

Corporate bonds await RBI policy. Corporate bond markets remained buoyant drawing cues from the G-sec market following the weaker than expected GDP numbers amid benign inflationary environment. The market saw a good deal of activity in the shorter end with yields compressing by 5-10 bps in the 1-2 yr segment. The longer end, however, remained flattish with traders awaiting the policy for further cues. In primary deals for the week, NHAI and NHPC were the large issuances. We saw volumes in primary market of approx. Rs 6000 Cr for the week. Pipeline for next week include issaunces from REC and NTPC post the monetary policy.

RBI likely to soften its tone in the June policy. With average 1HFY18 inflation likely to be ~130 bps (Kotak's estimates) lower than RBI's estimates, the policy stance should soften as early as in the June meeting to acknowledge the significant downward bias to its estimates.. A lower-than-expected trajectory for the RBI should prompt it to reassess its current views. Even as we expect RBI's tone to soften, we continue with our call of an extended pause as the 2HFY18 headline inflation is likely to still remain higher than the medium-term target of 4%.

FY17 growth turns out weaker. CSO revised down its FY2017 real GVA growth estimate marginally to 6.6% - making the deceleration from FY2016's 7.9% even sharper. Government spending contributed ~1.4 ppt to FY2017 growth. We look for a gradual recovery in FY2018 at 6.8%, given tepid private sector investment amid continuing debt overhang and slower growth in government spending.

Source : Equity Bulls

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