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CRISIL’s outlook on near-term rates

June 2020

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Research

Analytical contacts

Jiju Vidyadharan

Senior Director - Funds & Fixed Income Research [email protected]

Richa Dhariwal

Associate Director, Funds & Fixed Income Research [email protected]

Ankit Kala

Associate Director, Funds & Fixed Income Research [email protected]

Dharmakirti Joshi Chief Economist

[email protected] Dipti Deshpande

Senior Economist, CRISIL Ltd.

[email protected]

Research

Government security (G-sec) yields came down a notch in May due to rate cut, demand for government securities despite the government’s announcement of higher borrowing and a Rs 20 lakh crore financial package to combat the economic fallouts of the Covid-19 pandemic.

Yield on the 6.45% 2029 G-sec, the 10-year benchmark, opened the month at 6.07%, reached 6.16% mid-month, and closed at 6.01% – down 10 basis points (bps) compared with its April close of 6.11% – within CRISIL’s forecast range of 5.90-6.15%.

Yields trended lower in the first half of the month, following the US Federal Open Market Committee (FOMC) meet on April 29 that decided to maintain the current interest rate target between 0% and 0.25% until the economy recovers.

However, the Reserve Bank of India’s (RBI) announcement of an increase in the government’s market borrowings to Rs 12 lakh crore, from Rs 7.80 lakh crore, led to the yield reaching 6.16% – the highest in the month.

This was followed by the announcement of a Rs 20 lakh crore stimulus package – equivalent to 10% of gross domestic product (GDP) – by the government. The financial package is aimed at making India self-reliant on five pillars – economy, infrastructure, system, vibrant demography and demand. This led to an easing in the yield, as

~Rs 8 lakh crore of this would be in the form of the RBI’s liquidity measures and some other measures would be in the form of credit guarantees for loans provided by banks, and actual short term fiscal expenditure would be much lower (1.2% GDP expected based on CRISIL calculations).

Also, in its emergency meeting on May 22, the RBI’s Monetary Policy Committee cut the policy repo rate by 40 bps, from 4.40% to 4%. This led to the 10-year benchmark closing at 5.95%, 8 bps lower than the previous day.

Towards the end of the month, yields edged up slowly as supply for G-Secs increased (including 32000 Cr for new 10 year G-Sec) and crude oil prices also rebounded, closing the month at $34.15/barrel, up from $18.11/barrel at April-end. This led to the benchmark yield closing the month at 6.01%.

Measured May

CRISIL’s outlook

Benchmark May 31,

2020 (A) June 30,

2020 (F) August 30, 2020 (F) 10-year G-sec yield 5.78% 5.80-

6.05% 6.00- 6.30%

10-year SDL yield 6.49% 6.50-

6.80% 6.75- 7.05%

10-year corporate

bond yield 6.78% 6.75-

7.05% 7.00- 7.30%

Levels and forecasts for the new benchmark/ on-the-run securities (5.79 GS 2030) (Starting this month, the forecast will shift from 6.45 GS 2029 to 5.79 GS 2030) A: Actual; F: Forecast

Source: CRISIL Research

One-month view

June yields are likely to be affected by local and global growth scenarios as countries ease restrictions on business and movement, developments on the fiscal and monetary fronts, measures announced by the government or regulators, global interest rates, crude oil prices and foreign portfolio investment (FPI) flows.

Three-month view

In the three months through August, the pressure of fiscal deficit due to local and global increased borrowing programmes, global interest rates, crude oil prices, and open market operations by the RBI will dictate yields.

Framework for outlook

CRISIL provides its outlook on key benchmark rates for different debt classes – 10-year G-secs, corporate bonds, and state development loans (SDLs). The outlook is arrived at by combining statistical models with inputs from our experts. The judgement incorporates our view on policy expectations, macroeconomic outlook, key events (Indian and global), market factors (liquidity and demand/supply), among others.

On interest rates

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Research

Economic parameter Our view Impact on

yields Gross domestic

product (GDP) growth

• We expect India’s GDP to decline 5% on-year in fiscal 2021 compared with 4.2% growth in fiscal 2020

• Extended period of lockdown, higher than expected economic cost and smaller-than-expected policy push to revive demand in the short term, weigh on the growth outlook. This is in addition to the blow on the external front. Agriculture to grow near its trend

• GDP growth slowed to 3.1% in the fourth quarter of fiscal 2020 compared with 4.1% the previous quarter. Growth estimate for fiscal 2020 is now 4.2% compared with 6.1% in fiscal 2019 Consumer price index

(CPI) inflation • Inflation is expected to moderate to 4% in fiscal 2021 from 4.8% in fiscal 2020

• Lockdown-induced demand destruction would put significant downward pressure on core inflation this fiscal. Fuel inflation too is expected to remain soft. Food inflation, though, may limit the downside to inflation

• CPI inflation slowed to 5.8% in March from 6.6% the previous month

RBI’s monetary policy • The RBI cut policy rates by 40 bps in its monetary policy meeting preponed to May 22. With this, the repo rate stands at 4%, reverse repo rate at 3.35%, and marginal standing facility rate at 4.25%. The swift action by the Monetary Policy Committee was driven by the rapid deterioration of growth outlook due to Covid-induced lockdown

• The RBI is expected to maintain extremely accommodative monetary policy stance this fiscal with the sharp decline in growth and inflation remaining in the safe zone

Fiscal deficit • Strain on government finances will intensify with the falling GDP and tax revenue. Impact of the economic stimulus is expected to be small at ~1.2% of GDP in fiscal 2021

• The centre has already revised up its gross market borrowing to Rs 12 lakh crore for this fiscal compared with Rs 7.8 lakh crore budgeted earlier

• Fiscal stress is also being felt by states, given that they are at the forefront of the pandemic response, while their revenue is drying up. The increase in states’ borrowing limits by at least 0.5% of state domestic product will further add to bond market supply

Crude oil prices • CRISIL Research expects crude prices to range $30-35/ barrel in 2020, compared with an average of $64/barrel in 2019

• Brent crude oil prices rebounded to $31/barrel in May on average, compared with $23.3/barrel previous month, but remain much below $70.5/barrel in May last year

Factors influencing outlook

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Research

Economic parameter Our view Impact on

yields Current account deficit

(CAD) • CAD is expected to narrow significantly to 0.2% of GDP in fiscal 2021 compared with estimated 1% of GDP in fiscal 2020

• While exports face significant risks from weak global environment, sharp drop in crude oil prices, along with weak domestic demand, will pull down imports further

• Merchandise exports declined 60.3% on-year in April, after declining 34.6% in March. Imports declined 58.6% in April following a 28.7% decline in March. Trade deficit narrowed

$8.6 billion on-year to $6.8 billion – the lowest deficit since May 2016

US Federal Reserve’s

stance • The Fed is expected to maintain its ultra-accommodative monetary policy given the weak growth outlook

• The Fed maintained its policy rate at 0-0.25% in its April meeting. It will maintain this range until it is confident that the pandemic-induced economic shock has weathered out Liquidity indicators

- Demand & Supply

Supply side

• As per the revised H1 borrowing calendar, borrowing of Rs 1.5 lakh crore is scheduled to take place in June 2020 through papers of various tenors, including Rs 54,000 crore through the new 10-year benchmark

Demand side

• Demand is expected to remain strong on account of excess liquidity in system, weak credit environment and preference for safer investments

- Call rates/LAF (liquidity adjustment facility)

• Interbank call money rates remained below the RBI’s repo rate of 4% for most of May owing to comfortable liquidity in the system. However, some pressure was seen on the rates following intermittent spike in demand for funds from banks

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Research

5.60%

5.70%

5.80%

5.90%

6.00%

6.10%

6.20%

30-Apr-20 01-May-20 02-May-20 03-May-20 04-May-20 05-May-20 06-May-20 07-May-20 08-May-20 09-May-20 10-May-20 11-May-20 12-May-20 13-May-20 14-May-20 15-May-20 16-May-20 17-May-20 18-May-20 19-May-20 20-May-20 21-May-20 22-May-20 23-May-20 24-May-20 25-May-20 26-May-20 27-May-20 28-May-20 29-May-20

10-year G-sec benchmark yield New 10-year G-sec benchmark yield

Yields on corporate bonds witnessed easing of 44 bps to 6.78%, while that on SDLs eased by 31 bps to 6.49% from April close due to positive market sentiment post announcement of the fiscal stimulus.

May at a glance

Spreads narrowed for both corporate bonds and SDLs

The spreads of 10-year SDLs over G-sec narrowed to 20 bps over the previous month. AAA-rated public sector corporate bonds witnessed narrowing of 33 bps. Fiscal stimulus, the RBI’s rate cut announcement and adverse GDP forecast were the reasons for narrowing of spreads between G-secs and bonds.

FOMC stance remains accomodative

10-year benchmark G-sec yield

10-year benchmark yields

Spreads over G-sec (%)

Rate cut announced Revised borrowing calendar

for May-Sep 2020

20 Lakh Cr fiscal stimulus announced

0.00%

0.50%

1.00%

1.50%

31-May-12 30-Nov-12 31-May-13 29-Nov-13 30-May-14 28-Nov-14 29-May-15 30-Nov-15 31-May-16 30-Nov-16 31-May-17 30-Nov-17 31-May-18 30-Nov-18 31-May-19 30-Nov-19 29-May-20

SDL spreads Corporate bond spreads 5.00%

6.00%

7.00%

8.00%

9.00%

10.00%

11.00%

31-May-12 30-Nov-12 31-May-13 29-Nov-13 30-May-14 28-Nov-14 29-May-15 30-Nov-15 31-May-16 30-Nov-16 31-May-17 30-Nov-17 31-May-18 30-Nov-18 31-May-19 30-Nov-19 29-May-20

10-year G-Sec 10-year SDL 10-year corporate bonds

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Research

Systemic liquidity

* Net liquidity is calculated as Repo + MSF(marginal standing facility) + SLF (statutory liquidity facility) - Reverse repo

Interbank call money rates remained mostly below the RBI’s repo rate of 4% in May owing to comfortable liquidity in the system.

However, some pressure was seen on the rates following intermittent spike in demand for funds from banks. Systemic liquidity averaged ~Rs 5.1 lakh crore for the month due to higher liquidity at the start of the month, and ended the month at ~Rs 4.14 lakh crore.

Spreads narrow for most sector-rating categories with the announcement of fiscal stimulus

Spreads over G-sec*

Rating

category Date PSUs /

corporates NBFC Housing finance companies

AAA 30-Apr-20 1.06% 2.46% 2.11%

31-May-20 0.21% 2.01% 1.46%

AA+ 30-Apr-20 2.43% 4.75% 4.57%

31-May-20 1.80% 5.40% 2.81%

AA 30-Apr-20 3.96% 7.34% 5.34%

31-May-20 3.00% 7.60% 4.93%

AA- 30-Apr-20 4.61% 8.29% 6.11%

31-May-20 4.19% 8.01% 7.06%

*Spreads are for five-year securities over annualised G-sec yields. The 5-year G-sec benchmark has changed from 6.18% GS 2024 to 7.72% GS 2025

Average trading volume down across almost all securities, except SDLs

& G-secs

Trading volume of treasury bills decreased by ~32%, CPs decreased ~16%, CDs decreased ~50% on-month and corporate bonds ~7%. Meanwhile, trading volume of G-secs increased by ~44% and SDLs, by

~28%.

Net liquidity injected [injection (+)/absorption (-)]* (Rs crore) Monthly average trading volume (Rs crore)

0 10000 20000 30000 40000 50000 60000

0 2000 4000 6000 8000 10000 12000 14000

Mar-20 Apr-20 May-20 12 Month- Avg

SDL T-Bill CD

CP Corporate Bonds G-Sec (R.H.S.)

-700000 -600000 -500000 -400000 -300000 -200000 -100000

0 01-Jan-20 16-Jan-20 31-Jan-20 15-Feb-20 01-Mar-20 16-Mar-20 31-Mar-20 15-Apr-20 30-Apr-20 15-May-20 30-May-20

Net liquidity injected [injection (+)/absorption (-)] *

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Research

The average spread between the repo rate and the 10-year benchmark G-sec yield was ~175 bps in May (~187 bps in April), which is wider than the 12-month average spread of ~133 bps and the 10-year average of ~86 bps. The new benchmark had a spread of ~178 bps over the repo rate at the end of May.

Historical term premium

FPI outflows from debt continue

In May, FPI outflows were Rs 7,356 crore due to debt outflows exceeding equity inflows. The net outflow from debt stood at Rs 22,935 crore, whereas inflows to equities were Rs 14,569 crore.

The spreads between the 10-year benchmark G-Sec and 10-year US Treasury yields narrowed by 11 bps to 5.36%. The US Trea- sury yield closed in May at 0.65%.

Spread over US Treasury narrows

Benchmark yields – 10-year G-sec and US Treasury

FPI net investment in debt (Rs crore)

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

10.00%

30-Apr-09 30-Nov-09 30-Jun-10 31-Jan-11 31-Aug-11 31-Mar-12 31-Oct-12 31-May-13 31-Dec-13 31-Jul-14 28-Feb-15 30-Sep-15 30-Apr-16 30-Nov-16 30-Jun-17 31-Jan-18 31-Aug-18 31-Mar-19 31-Oct-19 31-May-20

INR 10-year G-Sec US 10-year G-Sec

43 3,414

(10,198) (9,978)

5,610 4,749

(1,301) (6,037)

12,002

(5,099) 1,111

8,319 9,433 11,672

(990) 3,670 (2,358) (4,616)

(11,648) 2,097

(60,376) (12,552)

(22,935)

-70000 -60000 -50000 -40000 -30000 -20000 -10000 0 10000 20000

Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 Mar-19 Apr-19 May-19 Jun-19 Jul-19 Aug-19 Sep-19 Oct-19 Nov-19 Dec-19 Jan-20 Feb-20 Mar-20 Apr-20 May-20

-0.50%

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

31-May-09 31-May-10 31-May-11 31-May-12 31-May-13 31-May-14 31-May-15 31-May-16 31-May-17 31-May-18 31-May-19 31-May-20

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Research

Key downgrades and upgrades in the past one month

Downgrades

Issuer name Old rating New rating

ECL Finance Ltd [ICRA]AA-/PP-MLD

[ICRA]AA- [ICRA]A+/PP-MLD [ICRA]A+

Edelweiss Finvest Pvt Ltd [ICRA]AA-/PP-MLD

[ICRA]AA- [ICRA]A+/PP-MLD [ICRA]A+

Edelweiss Housing Finance Ltd [ICRA]AA- [ICRA]A+

Edelweiss Retail Finance Ltd [ICRA]AA- [ICRA]A+

Edelweiss Rural & Corporate Services Ltd [ICRA]AA- [ICRA]A+

ECap Equities Ltd PP-MLD [ICRA]AA- PP-MLD [ICRA]A+

Tourism Finance Corporation Of India Ltd BWR AA- BWR A+

Future Lifestyle Fashions Ltd CARE AA- CARE A+

Edelweiss Asset Reconstruction Co Ltd [ICRA]A+/[ICRA]AA-

(CE) [ICRA]A/[ICRA]

A+(CE)

Future Retail Ltd CARE A+ CARE A-

Future Supply Chain Solutions Ltd CARE A+ CARE A-

Future Enterprises Ltd CARE A CARE BBB+

Future Consumer Ltd CARE A CARE A-

Rivaaz Trade Ventures Pvt Ltd CARE A(CE) CARE BBB+(CE)

Future Ideas Co Ltd BWR A-(CE) BWR BBB+(CE)

Nufuture Digital (India) Ltd BWR A-(CE) BWR BBB+(CE)

Essel Infraprojects Ltd BWR C(CE) BWR D(CE)

Upgrades

Issuer name Old rating New rating

Allahabad Bank IND AA- IND AA+

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About CRISIL Limited

CRISIL is a leading, agile and innovative global analytics company driven by its mission of making markets function better.

It is India’s foremost provider of ratings, data, research, analytics and solutions, with a strong track record of growth, culture of innovation and global footprint.

It has delivered independent opinions, actionable insights, and efficient solutions to over 100,000 customers.

It is majority owned by S&P Global Inc, a leading provider of transparent and independent ratings, benchmarks, analytics and data to the capital and commodity markets worldwide.

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CRISIL Research, a division of CRISIL Limited (CRISIL) has taken due care and caution in preparing this Report based on the information obtained by CRISIL from sources which it considers reliable (Data). However, CRISIL does not guarantee the accuracy, adequacy or completeness of the Data / Report and is not responsible for any errors or omissions or for the results obtained from the use of Data / Report. This Report is not a recommendation to invest / disinvest in any company / entity covered in the Report and no part of this report should be construed as an investment advice. CRISIL especially states that it has no financial liability whatsoever to the subscribers/ users/ transmitters/ distributors of this Report. CRISIL Research operates independently of, and does not have access to information obtained by CRISIL’s Ratings Division / CRISIL Risk and Infrastructure Solutions Limited (CRIS), which may, in their regular operations, obtain information of a confidential nature. The views expressed in this Report are that of CRISIL Research and not of CRISIL’s Ratings Division / CRIS. No part of this Report may be published / reproduced in any form without CRISIL’s prior written approval.

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RateView

Research

RateView

CRISIL’s outlook on near-term rates

June 2020

Research

Analytical contacts

Contents

Research

Measured May

CRISIL’s outlook

One-month view

Three-month view

Framework for outlook

On interest rates

Research

Factors influencing outlook

Research

Research

May at a glance

Spreads narrowed for both corporate bonds and SDLs

Research

Systemic liquidity

Spreads narrow for most sector-rating categories with the announcement of fiscal stimulus

Average trading volume down across almost all securities, except SDLs

& G-secs

Research

Historical term premium

FPI outflows from debt continue

Spread over US Treasury narrows

Research

Key downgrades and upgrades in the past one month