DebtFX: Growth-Inflation Conundrum Intensifies

Sentiments in both debt and currency markets are expected to turn cautious because of the recent release of inflation data, says India Ratings and Research (Ind-Ra). This week, the 10-year benchmark yield is likely to be in the range of 7.44%-7.50% (7.44% at previous week's close) while the rupee might range between 66.40-67.10/USD range (66.77/USD at previous week's close).

Bond Market Range to Inch Up: The data on Consumer Price Index inflation and Wholesale Price Index inflation for April 2016 show a considerable uptick in overall inflation, mostly driven by food components. The Consumer Price Index for April 2016 came at 5.39% (March 2016: 4.83%). Wholesale Price Index for April 2016 entered into positive territory at 0.34% after 17 months. This higher-than-expected inflation number practically rules out scope for rate cut in the next policy in June 2016, although the near-term expectation for a rate cut was anyway low. On the other hand, the Index of Industrial Production came in lower at 0.1% yoy for March 2016.

The higher inflation number and forecasted delay in monsoon arrival at southern part of the country by the meteorological authority do not augur well for sentiments in the capital market. However, Ind-Ra expects an open market operation (OMO) purchase in the coming fortnight could check the spike in yield, with the benchmark yield staying in the 7.42%-7.50% range.

Scope for OMO Purchases: As highlighted in the last week, overall systemic liquidity deficit has inched up caused by an increase in the currency in circulation (CIC), building up government cash balances to around INR300bn due to monthly tax flows. With the increase in leakages due to higher CIC, the core liquidity infusion by the Reserve Bank of India (RBI) increased to 0.85% of net demand and time liabilities compared to the last week's average of 0.65%. Ind-Ra expects the systemic liquidity requirement to increase further in the coming fortnight due to a further increase in CIC, which may necessitate another OMO purchase.

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