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Executive Summary
Global outlook: Global economy under transition
The global economy is in a transition phase, as the US economy prepares to shift from an extremely low
interest rate regime. The surge in volatility suggest that the Fed QE tapering is coming sooner (i.e. September)
rather than later (i.e. December). Sharp surge in US interest rate will have negative implication for US growth
while at the same time ramification for EM economies. EM economies are presently exposed to sudden sharp
capital outflows as external sector vulnerability has increased over the last few years. EM central banks now
faced with a trade-off between growth objectives and stability in bond and currency markets. We believe that
the Fed policy makers will adjust the QE tapering program such that the rate normalization cycle is gradual.
State of the Indian economy: Economy in a crucible of uncertainty and volatility
The Indian economy has gone through a watershed period during the past two months, which will structurallyalter the way policymakers grapple with macroeconomic decision making. The RBI undertook interest rate
defense for a sharply depreciating currency but we should keep in mind the core structural reasons, which has
caused this crisis and which require credible and sustainable commitment to long term on ground reforms and
not just short term palliatives.
Currency: Rupee remains under tremendous pressure
The depreciation pressure on Indian Rupee persisted through the month of August. The normalization of the
US yield curve has led to the significant capital outflows from EM economies including India. To prevent the
depreciation pressure in the Indian Rupee, RBI tightened liquidity conditions by raising the short term interest
rate. The previous episodes of monetary tightening suggest mixed impact on INR. Indias rising external sector
vulnerability too is weighing on Rupee. Creating an enabling environment key to stability in the Indian Rupee.
Rates: Markets under severe stress as RBI strives to save the Rupee
The bond markets have witnessed heavy volatility primarily on RBI's measures as part of the interest rate
defense policy strategy to save the Rupee. The yields are likely to remain elevated tracking the Rupee with its
fate linked to Fed policy stance and hence the September 17-18 FOMC meeting will remain in focus. Moreover,
the extent of inversion of the yield curve will increase with expectations of continued liquidity tightening with
the RBI likely to continue with the measures to address FX volatility.
Inflation: Upside risks to inflation from weak Rupee and rising food prices
Inflationary concerns have re-emerged as clearly signaled by the upward surprise in the July WPI inflation print.
Going forward, the sharp Rupee depreciation, rising global crude prices and up tick in metal prices, togethermake a case for upside risks to inflation. Overall, we expect WPI inflation to average 5.7% in FY2014, with an
average of ~5.2% in H1-2014 and a sharp rise to average 6.1% YoY in the second-half of the fiscal.
Feature: Analyzing risks to crude oil supply on account of Syria
Although Syria itself is not a major producer of crude oil, however any potential conflict in the country could
easily spill over to two major OPEC oil producers - Iraq and Iran. Besides, possible involvement of Iran in any
potential conflict could lead to disruptions in oil tanker flow through the Strait of Hormuz (which accounts for
20% of worlds oil trade). In a pessimistic scenario, oil production from Gulf countries (Saudi Arabia, Kuwait,Qatar and UAE) is also likely to be affected, especially if the Strait of Hormuz is disturbed. The future trajectory
of oil prices would depend on unfolding events in Syria in particular and the Middle East region in general.
Market Strategy MonthlyTreasury Research Group
For private circulation only
August 29 2013
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Market Strategy
Global OverviewSamir Tripat
The global economy is in
a transition phase, as the
US economy prepares to
shift from an extremely
low interest rate regime
The surge in volatility
suggest that the Fed QE
tapering is coming
sooner (i.e. September)
rather than later (i.e.
December).
Sharp surge in US
interest rate will have
negative implication for
US growth
Normalization of yield
curve will have
ramification for EM
economies
Global economy in transition
The global economy is in a transition phase, as the US economy prepares to shi
from an extremely low interest rate regime which will have a major implication f
global growth prospects as well as financial markets.
In light of gradual improvement in economic activity in the US, the consensu
view seems to be evolving that the ultra easy policy is not sustainable and the
are unintended consequences in terms of distorted asset price signals and hig
inflation down the line. In this regard, it should be noted that the key genesis fo
the US house price bubble during last decade and the subsequent credit crisis
2008-09 was led by the prolonged period of easy monetary stance adopted sinc
2000-01.
With gradual recovery in US, the focus has shifted to when and how the Fe
would begin the policy normalization process. The surge in volatility in th
financial market tends to suggest that the tapering of quantitative easing (QE)
coming sooner (i.e. September) rather than later (i.e. December).
The expectation that Fed will taper its asset purchase program, has led to a shar
reversal in US interest rates. As the Fed rhetoric on unwinding its monetary easin
stance gained traction in early May, the US Treasury bond market witnesse
significant sell off, with 10 year bond yield moving from 1.62% to 2.82% presentl
Given the sharp spike in US interest rate since May, a major part of the Fed Qtapering is already there in the price. Also the fact that further rise in US intere
rate will have negative implication for growth, the Fed policy makers will take no
of the rising macro risk of any such eventuality, especially for an econom
growing at a moderate pace. In this regard, it should be noted that US real GD
grew at a stronger-than-expected 1.7% QoQ (ann.) rate in Q2 against consensu
expectation of 1.0% QoQ (ann.) rise. Component wise, private consumption an
investment sector contributed 2.6 percentage points to growth while extern
sector/government spending were the key drag on growth, subtracting aroun
0.88 percentage points from overall growth. The US economy grew by 1.4%
an annualized rate in H12013. In the last FOMC meeting, the Fed expected U
GDP growth to be 2.3%-2.6% in 2013. To attain that kind of growth for full yeaUS economy will have to grow by 3.2%-3.8% in H2'2013. At this point this seem
highly unlikely. Further rising yields in the US has also led to a sharp increase
mortgage rates, which may set back the nascent housing market recovery that w
have seen so far.
On the other hand, the implication of normalization of interest rate cycle in US w
have significant ramifications for the EM economies, especially given the fact th
these economies were the key beneficiaries of the capital inflows during th
monetary easing cycle of 2008-2013.
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Market Strategy
EM economies are
presently exposed to
sudden sharp capital
outflows
The external sector
vulnerability has
increased in many EM
economies, especially
the ones running current
account deficit
The exchange rates
volatility will have
negative implications for
EM corporates with
unhedged FX exposures.
EM central banks now
faced with a trade-off
between growthobjectives and stability in
bond and currency
markets
We believe that the Fed
policy makers will adjust
the QE tapering program
such that the rate
normalization cycle is
gradual
With US interest rates rising, interest rates in EM countries have also gone u
significantly. The strong capital inflows" to EM economies in the past few year
expose these to large sudden reversals if markets expect an exit from
unconventional policies.
Normalisation of yield curves in core economies on the backdrop of narrowin
growth differentials in the EM-DM space and talks of moderation of stimulus in U
have put pressure on EM assets. Further evidence suggests that cross ass
correlations have significantly risen during the last five years and therefore there
scope of significant spillover impact on EM equities, currencies, and bon
markets.
Particularly, the external sector vulnerability has increased in many emergin
market economies, especially the ones running current account deficit, resulting
sharp depreciation in EM currencies. Brazilian Real, Indian Rupee, South Africa
Rand and Turkish lira are the key currencies that have depreciated by 15-18%since May 1st 2013.
This is further reflected in significant capital outflows from the EM economies
the last few months. For instance, India has witnessed capital outflows to the tun
of USD 11.6 bn since May 2013, out of which USD 9.0 bn is from the deb
segment and the remaining from the equity markets. Similar trend is witnesse
across other EM Asian economies.
To accentuate the problem further, the exchange rates volatility has led
pressures on EM debtors and will have negative implications for EM corporate
with unhedged FX exposures. Along with this, rising global interest rate scenar
will have adverse implications for debt servicing requirements of EM countries.
The rise in core economies yield curve have also led to the change in stance
Central Banks in the EM region where they are now faced with a trade-off betwee
growth objectives and stability in bond and currency markets.
To conclude, the global economic is in a transitionary phase and the reversal
easy monetary policy stance by the Fed will have implications for both the US a
well as global economies especially the EM economies. Rising rates in US has th
potential to slowdown growth in general and housing sector in particular. Th
spillover impact will also be felt in the EM economies, through capital outflow
and rising rates, at a time when growth is already adjusting at a lower leve
Amidst this backdrop, we believe that the Fed policy makers will adjust the Q
tapering program such that the rate normalization cycle is gradual and nodisruptive as has been the case during the last few months.
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Market Strategy
State of the Indian EconomyKamalika Das
This month witnessed theprecipitous fall in the
Rupee where it is now
within striking distance of
the 70 to a Dollar mark
and has seen a near
monotonic depreciation
trajectory for the past
few weeks.
The RBI chose to adopt
the interest rate defense
to stem the sharp fall in
the currency
Although short termmeasures are important
to check the first wave of
volatility and to shore up
sentiment and in the
process arrest capital
outflows but we must not
lose sight of the core
issues that caused the
deceleration in the first
place
Indian economy in a crucible of uncertainty and volatility
The Indian economy has gone through a watershed in the past two months,
which is likely to structurally alter the way policymakers view themacroeconomic landscape.
This month witnessed the precipitous fall in the Rupee where it is now within
striking distance of the 70 to a Dollar mark and has seen a near monotonic
depreciation trajectory for the past few weeks. This has predictably shaken the
foundations of all theories which are used to come to grips with the scenario.
In a snapshot, the most important consequence that we saw in the backdrop
of a falling Rupee was that the RBI adopted some form of interest rate defense
of the currency. Prima facie, there are broadly a few things that policy makers
can resort to in times of a sharp fall in the currency. They are viz. direct
intervention through the forex reserves channel, institute growth oriented
structural reforms or raise interest rates so that speculating against the home
currency becomes costlier.The RBI chose the latter option as it was likely to be the most effective given
that structural measures take a few quarters to pan out and our forex reserves
do not permit a sustained onslaught on market forces. As a result, we saw the
short term bank funding costs raised (read MSF hiked to 10.25%) and the LAF
channel curtailed. The RBI has also announced other forms of liquidity
withdrawal such as auction of cash management bills every week.
However, what came to pass was not a convincing amount of currency
stability as the Rupee continued to depreciate and other markets such as
equities and bonds reacted very violently in the negative territory. Taking into
cognizance these developments, especially on the bond markets, the RBI
capitulated a bit recently and made provisions that banks could make
accounting changes in lieu of their fixed income portfolio and that the RBI
would consider tapering its tightening action as and when required.
Since then there has been some degree of calm in the markets and most likely
positioning will be ranged in the run up to the crucial Federal reserve meeting
due later this month, which is likely to decide the fate of QE tapering.
Be that as it may, it stands to reason that although short term measures are
important to check the first wave of volatility and to shore up sentiment and in
the process arrest capital outflows but we must not lose sight of the core
issues that caused the deceleration in the first place. Our external sector has
increasingly become more vulnerable over the years and as a case in point,
our current account balance has gone up from being roughly balanced during
2004-05 to USD 88 bn last year. This sharp deterioration accompanied with an
equally sharp increase in short term debt obligations over the same period of
time is a significant cause for concern and needs to be addressed.
GDP growth has declined sharply in FY2013 IIP stagnates for Q1 FY2014
0
2
4
6
8
10
12
Q2FY2
006
Q4FY2
006
Q2FY2
007
Q4FY2
007
Q2FY2
008
Q4FY2
008
Q2FY2
009
Q4FY2
009
Q2FY2
010
Q4FY2
010
Q2FY2
011
Q4FY2
011
Q2FY2
012
Q4FY2
012
Q2FY2
013
Q4FY2
013
GDP at factor cost(% YoY)
-8
-3
2
7
12
17
Jun-12
Aug-12
Oct-12
Dec-12
Feb-13
Apr-13
Jun-13
Mining Manufacturing Electricity IIP
(% YoY)
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Market Strategy
The Q1 GDP data for
FY2014 is due to be
released end August and is
unlikely to show any
substantial improvement
in economic activity as
compared to Q4 FY2013,
which ended at 4.8% YoY
With the sharp
depreciation in the Rupee,
inflationary pressures are
likely to keep mounting in
the economy and are a
source of a parallel
macroeconomic concern
Fiscal arithmetic to be
adversely affected by food
and oil subsidies but
FinMin reiterates that
target will not be breached
The Finance Minister in his recent communication has reiterated that the
Government is well aware of the problems on the external front and that the
current account deficit has to be controlled as soon as possible. To this end, he
has committed to a target of CAD at USD 70 bn and has also announced
measures on the export front and hiked import duties on mainly precious
metals etc. While, this is an important step to begin with but care must also betaken that more deep rooted concerns such as raw material availability,
provision of core infrastructure, boosting productivity and enhancing skill
component etc are very important for the economy to take the next leap
forward to break out of the current vicious cycle and achieve the 8-9% growth
rates seen until recently.
In this context, we note that the Q1 GDP data for FY2014 is due to be released
end August and is unlikely to show any substantial improvement in economic
activity as compared to Q4 FY2013, which ended at 4.8% YoY. As far as high
frequency data is concerned, the scenario is fairly dismal as industrial
production as measured by IIP has averaged -1% YoY for April-June and the
services PMI component has gone into contraction territory in July for the first
time since 2011.
The only comfort seems to be on the agriculture front, where crop sowing data
shows that the Kharif crop is well on track and given fairly normal Monsoons
we should see some fillip on the farm output side. Apart from this, Government
spending in this quarter has also been fairly robust and the Government
balance with the RBI steadily decreased over Q1. This may provide some
respite to the community, social and personal expenditure front. However, the
two more important constituents of services, viz. trade, hotels and financial
services are likely to show weak growth. As a consequence, Q1 GDP is also
likely to be sub 5% and close to what we ended FY2013 with.
With the sharp depreciation in the Rupee, inflationary pressures are likely to
keep mounting in the economy and are a source of a parallel macroeconomic
concern. In other important developments, the Lok Sabha passed the Food
Security Bill, which is set to cover a population of around 82 crores and will
entail procurement of around 62 mn tons of grain. The fiscal impact in the
current year is however minimal and the full effect will only kick in next year
onwards. Given the current rate of sharp increase in oil prices globally, our
fiscal arithmetic will be adversely impacted through a rise in oil under
recoveries as well. In light of this, there are talks by the Oil Ministry of a INR
5/litre one off hike in diesel prices soon. Although, the fiscal looks to be under
stress from food and oil subsidies but the Finance Minister has reiterated firmly
that the budgeted estimate will not be breached.
Inflation showing a sharp uptick Short term rates to remain high for the moment
4.0
4.5
5.0
5.5
6.0
6.5
7.0
7.5
8.0
8.5
Jan-12
M
ar-12
M
ay-12
Jul-12
Sep-12
Nov-12
Jan-13
M
ar-13
M
ay-13
Jul-13
WPI(% YoY)
Source: CEIC, ICICI Bank Research
7.0
8.0
9.0
10.0
11.0
12.0
Jan-13
Feb-13
Mar-13
Apr-13
May-13
Jun-13
Jul-13
Aug-13
3m T bill(%)
Source: Bloomberg, ICICI Bank Research
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Market Strategy
Forex StrategySamir Tripath
The depreciation pressure
on Indian Rupee persisted
through the month of
August
The normalization of the
US yield curve has led tothe significant capital
outflows from EM
economies.
To prevent the
depreciation pressure in
the Indian Rupee, RBI
tightened liquidity
conditions by raising the
short term interest rate
Rupee remains under tremendous pressure
The depreciation pressure on Indian Rupee persisted through the month ofAugust and the currency has been one of the worst performers in the EM
currency basket. Though a part of the sell off in the currency markets reflect the
weak domestic fundamentals in some of these EM economies, the timing of the
selloff (i.e. May2013- present) suggest that expectation of the normalization of
yield curve in the US is the key trigger for the capital outflows from the EM
economies.
What is driving EM currency markets?
The normalization of the yield curve i.e. the unwinding of the monetary policy
stance in the US has led to the selloff in the US bond market, with the 10 year
treasury yield rising from a low of ~1.65% in April end to ~2.72% presently.The reversal in the US treasury market has acted as the trigger for the rotation
out of bond funds both in US and EM economies. This is reflected in significant
capital outflows from the EM economies in the last few months. For instance,
India has witnessed capital outflows to the tune of USD 11.6 bn since May 2013,
out of which USD 9.0 bn is from the debt segment and the remaining from the
equity markets. Similar trend is witnessed across other EM Asian economies. As
a result, since early May the correlation between 10 year US Treasury yield and
the EM currency basket has increased sharply.
Previous episodes of interest rate defense has mixed success in
combating INR depreciation
To address the capital outflows and thereby prevent the depreciation pressure
in the Indian Rupee, RBI has announced a series of measure to tighten liquidity
conditions by raising the short term interest rate. In this regard, we looked at the
three previous episodes (i.e. East Asian crisis (1997-98), Tech Bubble (2000-01)
and Global financial crisis (2007-08)) where in the RBI has raised interest rate
Out of the three episodes, during the East Asian crisis and Tech bubble episode
RBI measures were aimed toward addressing the Rupee volatility, during the
Credit crisis of 2008-09, RBI aimed to check inflation by tightening monetary
policy.
Reversal in US Treasury market has acted as
the trigger for rotation out of bond funds
thereby weighing on Emerging Market currencies
1.5
1.9
2.3
2.7
3.1
Jan-13
Feb-13
M
ar-13
Apr-13
May-13
Jun-13
Jul-13
Aug-13
US 10 year bond yield(%)
Source: Thomson Reuters, ICICI Bank Research
-0.6
-0.2
0.2
0.6
1.0
USDBRL
U
SDMYR
USDTRY
USDINR
USDZAR
USDIDR
Jan-April 2013 May 2013 -present
Correlation with US Treasury 10 year yield
Source: Bloomberg, ICICI Bank Research
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Market Strategy
The previous episodes of
monetary tightening
suggest mixed impact onINR
The previous episodes
depreciation pressure was
led by external factors.
Indias rising external
sector vulnerability too is
weighing on Rupee
Creating an enablingenvironment key to
stability in the Indian
Rupee
The key takeaways from the previous episodes of monetary tightening
measures:-
The duration of monetary tightening measures announced during theprevious three episodes lasted between 2-6 months
The impact of monetary tightening on USDINR is mixed. During theTech bubble episode, INR appreciated in the aftermath of the policy
reversal, in the other two episodes, INR continued to depreciate in the
~10-16% range, even after the reversal of the policy measures.
Monetary tightening measures partly led to growth slowdown duringthe Tech bubble episode (2001) and the more recent credit crisis of
2008-09. During these periods, monetary tightening lasted for ~6
months.
Indias growth during 2001 and 2008-09 was also impacted by overall slowdown
in global economy.
Takeaways for the presentAs a caveat, the past three episodes of heightened uncertainty discussed above
were primarily on account of external factors. In the present episode, although
Fed QE tapering triggered the depreciation in INR, worsening domestic
fundamentals and rising external sector vulnerability too is weighing on Rupee
sentiment.
The external vulnerability has worsened in the last few years, in light of the
rising current account deficit. In terms of financing the current account deficit,
though the stable sources of capital (i.e. FDI and ECB) has played a crucial role
in financing a part of the deficit, in the recent years i.e. 2010 onwards, reliance
on portfolio related flows have a key role in financing the CAD. This has
increased Rupees vulnerability in the recent years.
Creating an enabling environment for stability in FX market
Any policy announcement towards providing stability in FX market will require
a.) Encouraging stable capital flows in the near term and b.) Initiating urgent
structural reforms. Though the outlook for the capital flows will to an extent
depend on external development i.e. Fed policy meeting scheduled for
September 18th, the creation of enabling environment will go a long way in
attracting the stable source of flows i.e. FDI in the medium to long term.
USD/INR performance in previous episodes ofmonetary tightening measures
External vulnerability has worsened in the last fewyears, in light of the rising current account deficit
Qrt prior During the period QrtpostEast Asian financial crisis 8.6 -0.4 9.9
Tech bubble 2.7 4.7 0.8
Global Financial crises -2.2 9.8 16.4
USDINR performance during the period
Source: Reuters, ICICI Bank Research-20
-15
-10
-5
0
5
10
Mar-
00
Mar-
01
Mar-
02
Mar-
03
Mar-
04
Mar-
05
Mar-
06
Mar-
07
Mar-
08
Mar-
09
Mar-
10
Mar-
11
Mar-
12
Mar-
13
Financing the CAD (CAD+FDI+ECB)(USD bn)
Growing external sector vulnerability
Source: Bloomberg, ICICI Bank Research
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Market Strategy
Fixed Income StrategyKanika Pasricha
Bond markets arewitnessing heavy volatility
as the RBI has adopted an
interest rate defense for
the Rupee
Rupee under pressure on
domestic fiscal, growth &
inflation issues coupled
with Fed QE tapering
concerns
RBI has tightened liquidity
and increased cost of
liquidity to harden yields
and support debt flows
Yield curve has inverted
sharply since July 15th
Markets under severe stress as RBI strives to support the Rupee
The bond markets have witnessed heavy volatility over the last two months aspart of the global EM debt sell off amidst concerns regarding tapering of its
quantitative easing (QE) program by the US Fed later this year and more
importantly, on RBIs measures as part of the interest defense policy strategy to
save the depreciating Rupee.
Since early May, the Rupee has depreciated more than 20%, while the 10-year
bond yield has risen more than 150 bps to trade above a new threshold of 9%.
The slew of measures announced by the policymakers to stabilize the Rupee and
address the hardening of yields at the longer-end of the yield curve have shown
limited effect amidst weak investor sentiment.
RBI has adopted an interest rate defense for the Rupee and kept gilts
under pressure
The Indian currency has been the worst affected on account of concerns over
tapering of QE program by the US Fed, given our elevated current account
deficit and weak domestic fundamentals amidst slowing growth and rising
inflationary concerns. Against this backdrop, the RBI decided to adopt an
interest rate defense for the Rupee by increasing the cost of Rupee liquidity and
support debt flows amidst rise in yields especially for the shorter tenure.
Since 15thJuly, the RBI has adopted a slew of liquidity tightening measures as
highlighted in the section above. The liquidity tightening measures were
introduced in various tranches amidst persistence of depreciation pressure on
the Rupee and in order to ensure that the call rate trades consistently at the
higher end of the policy corridor at 10.25%.
The measures have led to a rise in systemic liquidity deficit to `1100 bn currently
as against ` 630 bn as of end-June. Our projections show that the liquidity deficit
is likely to increase beyond `1.5 trillion in September amidst advance tax
outflows, if the RBI continues with the liquidity tightening measures to support
the Rupee.
The consequent tightening of the liquidity situation has led to an inversion of the
yield curve, with the 3-month and 10-year yields rising by ~3% and ~1.5% since
15thJuly. The heavy supply pressures in August (`790 bn) have put an additiona
upward pressure on the yields. This led the authorities to announce some
measures to address the market conditions.
Yield curve has inverted sharply Gsec demand-supply dynamics reflect need forOMO buybacks
Yield curve
7.0
7.5
8.0
8.5
9.0
9.5
10.0
10.5
11.0
11.5
3M
6M2
Y3Y
4Y
5Y
6Y
6Y
8Y
9Y
10Y
11Y
12Y
13Y
14Y
15Y
19Y
24Y
30Y
23-Jul 15-Jul 27-Aug(%)
Source: Bloomberg, ICICI Bank Research
Supply FY2013 FY2014Dated securities 4675 4840
Tbills 280 198
Net SDL issuance 1453 1453
Total 6408 6491
Demand FY2013 FY2014SLR demand by banks 2360 2630
Demand from PFs & insuance companies 1803 1830
Demand from Mutual funds 350 200
Demand from FIIs 210 0
Demand from RBI 1685 1831^
Total 6408 6491
Excess demand/(supply) - -
Demand and Supply for G-secs ( bn)
^Depending upon RBI policy objectives at various points of time assuming 29% of NDTL and 14% deposit growth
Source: RBI ICICI Bank Research
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Market Strategy
To limit the hardening of
yields at the longer end of
the curve, the RBI has
announced variousmeasures to address
market conditions
The steps taken to protect
the Rupee have led
various banks to raise
base rates and have
affected liquidity invarious market segments
like CPs, CDs
However, credit growth
has spiked given the
relatively cheap funding
available through banks
Yields to remain elevated
amidst persistence of
depreciation pressure on
the Rupee
The RBI has decided to conduct OMOs to ease the pressure at the longer-end
of the yield curve. The RBI has been a key buyer of duration in the last few
fiscal years, with the OMO purchases worth more than `1600 bn in FY2013.
Our Gsec supply-demand projections also reflect the need for ~`2000 bn
worth demand from the RBI to match the heavy supply requirements.
Moreover, the pace of liquidity tightening through cash management bill salesis likely to be calibrated and scaled down as and when stability is restored in
the Rupee market. Further, the banks have been allowed to limit the accounting
losses on Gsec investments by transferring a part of trading portfolio into HTM
up to 24.5% of NDTL.
Various implications of liquidity tightening measures
The interest rate defense for the Rupee has helped reduce the pace of FIIoutflows from the debt markets to USD 1.2 bn in August versus USD 7.6 bn
cumulative in June and July. Nevertheless, the extent of FII debt utilization
has slipped from 55% of the limits in early May to 37% currently.
Rise in cost of borrowing has led various banks to raise base rates over thelast fortnight. This has increased downside risks to our FY2014 growth
projection as it would delay the recovery in investment cycle.
Gsec trading volumes have declined sharply with the average grossvolumes declining to `160 bn in August-2013 versus `550 bn in April.
Market liquidity has reduced sharply in various market segments like CPsand CDs, with the issuances in CP and CD market slipping to `66.0 bn and
`32.4 bn respectively in the second fortnight of July versus ` 277.2 bn and
`105.9 bn in the last fortnight of April.
Mutual funds as market participants have shifted their funds deploymenttowards CBLO markets from CD market. The latest data for the month of
July-2013 shows that the funds have reduced their investments in CDs by `
350 bn, while their CBLO market exposure has been increased by `380 bn.
Despite the rise in downside risks to growth, the credit growth has surgedto 16% levels as per the latest data. This is possibly attributable to thesubstitution of CP issuances with the relatively cheap bank credit by the
corporates. A similar trend is being witnessed in case of NBFCs. Moreover,
mutual funds witnessing heavy redemption pressures are taking the OD
facility against FD from the banks, to meet the demand for funds.
Yields to remain elevated amidst a pressured Rupee
Bond markets remain under intense pressure tracking the Rupee with its fate
linked to Fed policy stance. In this context, the September 17-18 FOMC
meeting is in focus. Moreover, the extent of inversion of the yield curve will
increase with expectations of continued liquidity tightening with the RBI likely
to continue with the measures to address FX volatility.
Credit growth above 16% on market disruptions FII debt utilisation has dropped to sub 40%
11
13
15
17
19
21
Aug-11
No
v-11
Feb-12
Ma
y-12
Aug-12
No
v-12
Feb-13
Ma
y-13
Aug-13
70
72
74
76
78
80
credit-deposit ratio (RHS) Aggregate deposits Credit
(% YoY) (%)
Source: Bloomberg, ICICI Bank Research
S.No as onUpper Cap Debtutilization Upper Cap
Debtutilization
(USD bn) ( ) (USD bn) ( )1 Government Debt 30.0 43.8 25.0 76.4
(i) 25.0 52.5 25.0 76.4(ii) ^^ 5.0 6.4 0.0 0.0
1(a) Treasury Bills 5.5 60.7 5.5 93.82 Corporate Debt 51 33.0 51.0 43.6
2(a) Commercial Papers 3.5 69.5 3.5 81.5 Grand Total 81.0 37.1 76.0 54.7
FII debt Utilisation Status27-Aug
Type of Instrument
10-May
^^Investments by long-term investors such as SWFs, multilateral agencies,pension & insurance funds and foreign central banks
Source: NSDL ICICI Bank Research
8/13/2019 Market Strategy of ICICI Bank
10/17
Market Strategy
InflationKanika Pasricha
WPI inflation provided a
sharp upward surprise in
the July print
There was a broad based
spike in sub-components
Core inflation increased as
manufacturers decided to
pass on the rising costs
due to Rupee depreciation
Going forward, Rupee
depreciation, rising global
crude prices and up tick in
metal prices, pose upside
risks to inflation
We expect WPI to average
5.7% in FY2014, with core
inflation likely to surge
past 3% mark in H2
FY2014
Upside risks to inflation from weak Rupee and rising food
prices
Inflationary concerns have re-emerged as clearly signaled by the sharp upward
surprise in the July WPI inflation print that came in at 5.79% YoY versus
consensus estimate of 5% YoY and a full percentage point higher compared to
4.7% average inflation in Q1 FY2014.
Looking at the details of the July inflation print, the food inflation spiked to
11.9% YoY versus 9.7% YoY in the previous month. This is primarily attributable
to a 46.6% YoY rise in vegetables prices amidst a 144.9% YoY increase in
inflation in onions. Further, fuel inflation increased to 11.31% YoY versus prior
reading of 7.12% YoY. The sequential momentum of the fuel index jumped to
3% MoM as against 1.1% MoM, with a contribution of 8.2% MoM from the non-
administered component while the administered prices increased by 1.36%MoM. Moreover, the non-food manufactured products inflation rose to 2.33%
YoY after slipping to a 3 year low of 2.1% YoY in June. The sharp Rupee
depreciation has pressured the manufacturers to raise prices in spite of weak
pricing power, with the sequential momentum of core inflation increasing to
0.53% MoM, highest since April-2012.
Going forward, the sharp Rupee depreciation, rising global crude prices and up
tick in metal prices, all together make a case for upside risks to inflation in the
near term. The core inflation component is 55% of the WPI basket and 50% of
this basket is composed of metals and chemicals, with their domestic prices are
determined by the import parity prices (in INR terms). Hence, Rupee
depreciation is likely to have a significant impact on core inflation.
The authorities are also considering a one-time hike in diesel prices by ` 5/Lgiven that the rising global crude prices amidst geopolitical tensions in the
Middle East has led to a rise in diesel under-recovery to `10/L from `3/L in late-
April. The 20% depreciation in the Rupee coupled with rise in crude and meta
prices is likely to feed into core and non-administered fuel inflation.
Overall, we expect WPI inflation to average 5.6-5.8% in FY2014, with an average
of ~5.2% in H1-2014 and a sharp rise to average 6.1% YoY in the second-half of
the fiscal. We also expect the core inflation to surge past 3% levels in H2
FY2014, with rising upside risks to this component.
Non-administered price increases amidst
elevated global crude prices driving fuel inflation
INR depreciation poses upside risks for core
inflation
-10
0
10
20
30
40
Ju
l-10
Oct-10
Jan
-11
Apr-11
Ju
l-11
Oct-11
Jan
-12
Apr-12
Ju
l-12
Oct-12
Jan
-13
Apr-13
Ju
l-13
0
2
4
6
8
10
12
14
16
18
Non-admin istered Admin istered (RHS)Fuel inflation
(% YoY) (% YoY)
So ce Bloo be g ICICI Ba k Resea ch
-30.0
-15.0
0.0
15.0
30.0
Au
g-12
Se
p-12
Oct-12
No
v-12
De
c-12
Ja
n-13
Fe
b-13
Mar-13
Apr-13
Ma
y-13
Ju
n-13
Jul-13
Au
g-13
0.0
2.0
4.0
6.0
8.0
CRB index CRB (INR adjusted) WPI-core (RHS)
(% YoY)
Source: Bloomberg, ICICI Bank Research
8/13/2019 Market Strategy of ICICI Bank
11/17
Market Strategy
Feature: Analyzing risks to oil supply on account of escalating tensions in SyriaTadit Kundu
Brent crude oil pricebreached the USD 117/bbl
level on Wednesday for
the first time in six
months
Recent statements by US
officials have raised
speculation of possible
military action
Crude oil prices hovering around the highest levels in six months
The Brent oil price on Wednesday breached the USD 117/bbl level for the firsttime in six months, as speculation rose that the US might conduct military
strikes against the Syrian Government (over the episode of an alleged chemica
weapons attack in Syria). The Brent price is currently hovering around USD
116/bbl, while WTI is hovering around USD 111/bbl. Recent statements by US
and UK Government officials have raised speculation of possible military action
Meanwhile, US reportedly moved four warships in the Mediterranean Sea, close
to the Syrian coast.
The analysis below tries to put in context the risks to oil supply emanating from
any potential conflict around Syria.
A confluence of geopolitical issues Syria, Libya and Egypt have raised risks to oil supply from
the Middle East and North Africa region
8/13/2019 Market Strategy of ICICI Bank
12/17
Market Strategy
Syria per se is not a major
oil producer
However, Syria risks
engulfing the entire region
Iraq has shown rise in
political violence in recent
days, tied to happenings
in Syria
A. Why is Syria important for oil supply?Syria per se is not a major oil producerSyria currently produces around 28,000 barrels of oil per day (bpd), which is
only 0.03% of global oil output. Even at its peak, before the outbreak of the Civi
War, Syrian oil output was around 360,000 bpd (0.4% of global oil output).
Syria is not even a major oil transportation route:Unlike Egypt, which controls the important Suez canal, Syria cannot claim to
control any important oil supply route. The Kirkuk-Baniyas oil pipeline, which
used to transport oil from Iraq to Syrian coast, has remained out of operation
since 2003.
In short, Syria, p r s , is not important for the global oil market.
However, Syria risks engulfing the entire region
Owing to history and demographics, any potential Syrian conflict is very likely to
affect the neighbouring countries of Iraq and Lebanon, besides Iran. Of them,
Iraq and Iran are major oil producers and OPEC members.
A.1. Possible effect on oil supply from Iraq
Iraq has shown rise in political violence in recent days, tied to happenings in
Syria. According to the UN, the Iraq conflict death toll in July 2013 topped the
1000-level, the highest since April 2008. Consequently, there remain concerns
that oil facilities in Iraq might be disrupted if the Syrian conflict escalates and
Iraq becomes a proxy battleground.
Meanwhile, a conflict in Syria can also threaten the crucial 335,000 bpd Kirkuk-
Ceyhan pipeline, which transports oil from Iraq to Ceyhan oil terminal in Turkey
and runs close to the Turkey-Syria border.
Syrias crude oil output, even at its pre-War
levels, amounted to only 0.4% of global outputConflict poses risks to 335,000 bpd Iraq-Turkey
oil pipeline that runs along Turkey-Syria border
0
50
100
150
200
250
300
350
400
Jul-10
Oct-10
Jan-11
Apr-11
Jul-11
Oct-11
Jan-12
Apr-12
Jul-12
Oct-12
Jan-13
Apr-13
Jul-13
Syria crude oil output('000 bpd)
Source: Bloomberg, CICI Bank Research Source: News reports, ICICI Bank Research
8/13/2019 Market Strategy of ICICI Bank
13/17
Market Strategy
Iran has diplomatically
supported the Assad
Government in Syria
There remain concerns
that the Syrian conflict
might engulf Iran, thereby
prompting disruptions to
oil tanker flow through
the Strait of Hormuz
Continued political unrestin Egypt and Libya have
added to concerns over
stability of oil supply from
the region
In a pessimistic scenario,oil production from Gulf
countries (Saudi Arabia,
Kuwait, Qatar and UAE) is
also likely to be affected,
especially if the Strait of
Hormuz is disturbed
A.2. Possible effects on Iran
Iran has diplomatically supported the Assad Government in Syria. Various
reports have alleged that the Iranian Government is also materially supporting
the Assad Government. Involvement of Iran in the conflict could further reduce
its oil exports, already strained under US-EU sanctions.
A.3. Possible effects on the Strait of Hormuz
The Strait of Hormuz is a narrow waterway between Oman and Iran. It is an
important oil transit route, transporting around 17 mbpd of oil from the Middle
East region. Iran had previously threatened to close the Strait in case of
hostilities. There remain concerns that the Syrian conflict might engulf Iran
thereby prompting disruptions to oil tanker flow.
B. Other geopolitical issues in the Middle east region
B.1. Libya: strikes disrupt oil export terminals
Persistent political unrest and strikes by workers/security guards has led to
intermittent shutdown of the countrys export terminals. Therefore, Libyas oil
output fell to 0.8 mbpd in July from 1.4 mbpd in March.
B.2. Egypt: Continued unrest could endanger Suez oil flow
Egypt remains in a state of flux since a Government change in early July. There
remains possibility that tanker movement across the Suez canal might be
disrupted. However, the probability of such an event is as yet minimal
Moreover, Suez canal shutdown would only impose manageable hurdles to
global crude oil movement.
C. Overall picture: A confluence of factors has significantly increased
geopolitical risks
Thus, we already see conflict in Syria, Libya and Egypt along with concerns ofconflict quickly engulfing Iraq and Iran In a pessimistic scenario, oil production from Gulf countries (Saudi Arabia,
Kuwait, Qatar and UAE) is also likely to be affected, especially if the Strait of
Hormuz is disturbed
US military presence in both the Mediterranean Sea and the Persian Gulfadds to tensions
Consequently, oil prices are likely to climb even higher in the next few daysand could touch USD 120/bbl.
The future trajectory of oil prices would depend on unfolding events in Syriain particular and the Middle East region in general
In a pessimistic scenario, the Syrian conflictposes risks to oil supply from the Middle East consequently crude oil prices have spiked inrecent days
Saudi Arabia Iraq
Iran Outside ME*
Other ME* nations
World July crude oil production (% of world total)
Outs ideM idd le
East(74%)
M idd leEast*(26%)
ME*: Middle East (Egypt & Libya included for calculation purposes)
Source: Bloomberg ICICI Bank Research
100
104
108
112
116
120
3-Jul
10-Jul
17-Jul
24-Jul
31-Jul
7-Au
g
14-Au
g
21-Au
g
28-Au
g
Brent WTI(USD/bbl)
Source: Bloomberg ICICI Bank Research
8/13/2019 Market Strategy of ICICI Bank
14/17
Market Strategy
Unit Period Latest Previous FY13 FY12Real GDP % YoY Q4 FY13 4.8 4.7 5.0 6.3
Agriculture % YoY Q4 FY13 1.4 1.8 2.0 3.7
Industry % YoY Q4 FY13 2.7 2.5 2.1 3.5
Services % YoY Q4 FY13 6.6 6.7 7.1 8.2IIP % YoY Jun-13 -2.2 -2.8 1.2 3.1
PMI Index Jul-13 50.1 50.3 53.7 54.5
WPI inflation % YoY Jul-13 5.8 4.9 7.4 9.0
CPI inflation % YoY Jul-13 9.6 9.9 10.2 8.4
Unit Period Latest Previous FY13 FY12Exports % YoY Jul-13 11.6 -4.6 -2.7 24.7
Imports % YoY Jul-13 -6.2 -0.4 0.8 32.8
Trade balance USD bn Jul-13 -12.3 -12.2 -194.7 -183.4
Current Account USD bn Q4 FY13 -18.2 -31.8 -88.2 -78.3
Capital Account USD bn Q4 FY13 20.5 31.5 89.3 67.9
BOP USD bn Q4 FY13 2.7 -0.2 3.8 -12.8
FX reserves USD bn 16-Aug-13 278.8 278.6 0.3 0.0
Unit Period Latest Previous FYTDCorrespondingperiod last year
Auto Sales % YoY Jul-13 -1.3 -4.3 0.9 12.3
Passenger Cars % YoY Jul-13 -2.5 -12.1 -4.9 5.1
Commercial Vehicles % YoY Jul-13 -16.9 -23.1 -22.3 2.6
Cellular Subscribers % YoY May-13 -6.4 -5.9 25.3 45.0
Railway freight % YoY Jul-13 6.3 7.9 18.7 14.7
Unit Period Latest Previous FYTD avgCorrespondingperiod last year
INR bn 15725 15637 14429 11717
% YoY 7.1 7.1 23 103
INR bn 55091 54053 46050 39380
% YoY 16.6 13.5 17 19
INR bn 71037 70869 60786 52995
% YoY 14.1 13.7 15 15
INR bn 87697 87390 76134 66467
% YoY 12.2 12.5 15 16INR bn 21871 22167 21701 19356
% NDTL 28.3 28.8 28.8 29.0
Reserve Money 16-Aug-13
9-Aug-13
9-Aug-13
Credit outstanding
Aggregate Deposits
9-Aug-13Money Supply
SLR investment 9-Aug-13
Key macroeconomic Indicators
External Sector Indicators
Monetary Indicators
Leading indicators
8/13/2019 Market Strategy of ICICI Bank
15/17
Market Strategy
Unit Period Latest Previous FY13 FY12Fiscal Deficit as a% of
budgeted % June FY2013 48.4 33.3 94.0 98.9Total Expenditure as % of
budgeted % June FY2013 23.0 13.1 98.5 98.9
Total Rece pts as a % ofbudgeted % June FY2013 10.6 3.3 101.1 98.9
Policy Rates Unit Period Latest PreviousCumulativechange in
FYTD (bps)Cumulative change
in FY13Repo rate % 28-Aug-13 7.25 7.50 -25 -100
Reverse Repo % 28-Aug-13 6.25 6.50 -25 -100
CRR % 28-Aug-13 4.00 4.25 0 -75Auctions Unit Latest Previous FYTD FY13Dated security auction INR bn 28-Aug-13 150 150 2,840 5460
OMO Purchase INR bn 28-Aug-13 62.3 96.6 227 1550SMO Purchase INR bn 28-Aug-13 0 0 0 0MSS buyback INR bn 28-Aug-13 0 0 0 0
Unit Period LatestLast month
avg last month FYTDBSE Sensex Index 28-Aug-13 17852.10 18899.77 -9.86 0.90
Exchange Rate (USD/INR) - 28-Aug-13 68.16 61.90 15.31 53.36
364-day T-Bill % 27-Aug-13 9.98 9.92 5.51 91.9410-yr GOI bill % 27-Aug-13 8.88 8.77 4.72 13.55
OIS (5-year) % 28-Aug-13 9.07 8.57 9.02 31.85MIFOR (5-year) % 28-Aug-13 7.60 7.44 4.11 19.69
MIBOR (NSE) % 28-Aug-13 10.31 9.63 42.21 177.90
Unit Period LatestLast month
avg last month CYTDEuro - 28-Aug-13 1.3370 1.3322 0.69 -6.7
British Pound - 28-Aug-13 1.5517 1.55 0.88 -3.9
Japanese Yen - 28-Aug-13 97.45 97.81 -0.77 4.7Swiss Franc - 28-Aug-13 0.919 0.93 -1.01 -11.2
DOW - 28-Aug-13 14776 15307 -5.0 41.7
FTSE - 28-Aug-13 6415 6544 -2.1 18.5
Nikkei - 28-Aug-13 13338 13804 -5.6 26.5
Global PMI - Jul-13 50.8 50.6 0.2 0.2USD Libor 3mth % 27-Aug-13 0.26 0.26 -1.9 2.0Ted Spread bps 27-Aug-13 19.9 23.7 24.2 23.2
change since
Currencies
Fiscal Indicators
Equities
Others
RBI Action
Market Indicators change since
Global snapshot
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