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The prevailing growth inflation dynamics in India is unarguably due to a combination of lenient fiscal policy and tight monetary policy - which, in combination, have resulted in moderation in economic growth at one end, and inflation at the other end. In this whole episode, the Central Bank seems to have taken undue criticism for keeping policy rates high in an environment where growth is tapering off. The Government's inaction on reform and policy fronts is a relatively bigger reason for a steep moderation in growth.
While recognising the slowdown in growth, the central bank highlighted increasing upside risk from inflation, particularly due to the recent surge in crude oil prices, fiscal fall, and rupee depreciation. Also, there is a suppressed inflation component, as administered prices of fuel, fertiliser, and power don't fully reflect the costs of production. A credible fiscal consolidation from the Government will be an important factor in shaping the inflation outlook.
The Budget has been announced in a scenario with a steep moderation in growth on account of the slowdown in the investment cycle. On a better note, the government reversed a part of the fiscal stimulus, and announced a schedule for implementation of the Goods and Service Tax. However, while tax revenue projections seem a little stretched — as economic growth is unlikely to revive soon — the Subsidy Bill seems to be understated, even this time around.
The Central Government's Subsidy Bill is budgeted at approximately 1.9 per cent of GDP. The actual amount of aggregate subsidy budgeted is 12 per cent lesser than the 2011-12 estimate. Thus, unless there is some fuel deregulation underway, the budgeted subsidy amount this year also seems to be understated. Also, higher food subsidy expense is probable, on account of implementation of the Food Security Bill.
LIQUIDITY
We foresee continuation of tighter liquidity conditions in the system till the end of this month, followed by a relatively lesser liquidity deficit in April — much closer to RBI's stated range of plus / minus 1 per cent of net demand and time liabilities (NDTL) - given that the beginning of the year is a typically lower financing demand season, and also a sizable maturity of sovereign bonds is lined up in the first two months of the next fiscal. Thus, short term rates are likely to come down once we enter into April.
As we foresee a considerable deceleration in deposit growth to 13-14 per cent in 2012-13, primarily due to the stubborn structural inflation in play, the system liquidity is likely to fall into deficit once again, in excess of RBI's comfort zone, post June.
In such a situation, RBI is likely to resort to Open Market Options (OMOs), as the remaining two major modes of liquidity infusion — CRR reductions and Forex intervention — have limited scope. The amount of OMOs to be conducted in 2012-13 is expected to be in the region of Rs 1-1.5 trillion.
The increase in total borrowings, coupled with concerns on subsidies and expected revenue mop-up from the 2G spectrum sale, would start having a retarding effect on the longer end of the curve. Also, with a majority of redemptions in 2012-13 scheduled in the first half, the government will have to frontload the borrowing calendar. We expect the yield curve to come under pressure, and steepen as we head into next year. We expect 10-year government securities to hover in the 8.40-8.50 per cent range in the near future, and then move up to 8-60-8.75 per cent in the first quarter 2012-13. Post June, with RBI conducting OMOs, sovereign yields are likely to be ranged.
INVESTMENT OPTION
In the April-to-June period, government securities are likely to be hiked by 25-50 basis points, while short-term rates are likely to come down by 50-100 basis points. Thus, there would be a steepening of the yield curve, and hence an investment in short-term income and income funds with lower duration can be looked at.
Towards the conclusion of the first quarter, Gilt funds or long-duration funds can be looked at, as we anticipate that RBI will have to start once again with Open Market Operations, which, in turn, will keep a lid on government security yields.
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