Monthly
Treasury Research Group
Ashray Ohri
ashray.ohri@icicibank.com
Tel no: +91-22-4008-7249
Sumedha Dasgupta
sumedha.dasgupta@icicibank.com
Tel no: +91-22-4008-7243
Anushri Bansal
anushri.bansal@icicibank.com
Tel no: +91-22-4008-6220
July 1, 2019
Please see important
disclaimer at the end of
this report
For private circulation only
India Markets: On the edge
 Positive sentiment in the domestic bond markets continued in June, led by
further accommodation by the MPC and OMO purchases by the RBI. This
has been in sync with global bonds as well. However, gains have been
capped due to 1) fiscal concerns ahead of the budget 2) rebound in oil
prices and risk-on sentiment after G-20 summit
 Rupee has appreciated along with its Asian peers in response to the dovish
tilt from the Fed, which has weighed on the Dollar. However, intervention
by the RBI, along with rising oil prices, fiscal concerns and India-US trade
concerns have kept the rupee in a tight range
 Systemic liquidity is expected to build on its current surplus in July due to
large G-sec redemptions, government spending and currency inflows
Indian markets were driven by a flurry of global and domestic factors this month. In an
inflection move central banks across the globe made another dovish pivot early in June,
as ambiguity about trade war and its impact on global growth became more prominent.
This caused yields across the globe to fall to historic lows while equity markets held their
ground responding to the accommodative monetary policy guidance provided by central
banks. The G-20 summit which unfolded over the weekend appeased some of these
concerns as US and China attempted to broker a truce and restarted their trade talks after
an impasse of over 1 month. Markets have responded with constrained celebrations as
global yields have inched only relatively higher and the central theme around a dovish
monetary policy and growth concerns remain in place.
Indian markets have been close to follow global movements, as the India 10 Year G-sec
yields fell to its lowest in nearly two years at 6.73% on June 20, 2019. Alongside the
favourable global bond environment, domestic factors such as the RBI policy rate cut in
June (with a unanimous vote) and two additional OMO purchases worth INR 275 bn this
month, aided India bonds and rates market. The clear signal of a loose and
accommodative monetary environment further strengthened sentiment in the rates
market.
However, the rally has come under pressure in recent days on 1) concerns over the
possibility of fiscal breach in the upcoming (July 5, 2019) FY2020 Union Budget 2) report
on RBI capital transfer to government shifted to July 16th and indications that the capital
transfer from RBI to the government is likely to be insignificant 3) rise in oil prices. In
addition, the global developments over the weekend were bond negative. Apart from the
G-20 truce there was also an agreement between Saudi Arabia and Russia to extend
production cuts into early 2020. Given the uncertainty over the fiscal and other key
triggers, we expect the 10-year benchmark to trade between 6.80 – 7.20% in the near
term.
On liquidity, we expect the systemic surplus from June (~ INR 1trn on 28th June) to build
further going into July. Limited outflows due to the lean economic period, substantial G-
sec redemptions and continued government spending are likely to drive more inflows
into the system. Core liquidity has increased to ~ INR 700 bn and is likely to increase
further on currency inflows into the system. However, given the recent signaling from
the RBI in maintaining adequate surplus liquidity in the system we do not rule out the
announcement of a possible OMO worth INR 125-150 bn in July.
The Indian Rupee propped up against the Dollar along with its EM peers as the
greenback weakened after the Fed pivoted to the dovish side. The trade truce between
US and China has further boosted the EM pairs against the Dollar, however, strong
intervention by the RBI along with concerns on rising oil prices, ongoing India-US trade
disputes and a breach of fiscal concerns have limited the upside for the Rupee. On a
separate note, the 12 month implied yields on Rupee forwards has surged to two year
highs, widely believed on account of RBI sterilization operations in the forward market.
 Systemic liquidity - to maintain its surplus stance ahead
The Indian systemic liquidity turned into surplus in June as indicated in our previous report. Substantial G-sec
redemptions, OMO purchases and increase in government spending brought the systemic liquidity close to a ~INR 1
trillion surplus at the start of this month. However, strong outflows due to GST and advance tax collection retracted a large
part of the surplus. The second OMO purchase of INR 125 bn along with large coupon inflows towards the end of the
month have helped the system turn into a sizable surplus again. In addition, FX intervention by the RBI along with month
end expenditures have further propped up liquidity in the system, pushing the systemic surplus to ~INR 970 bn (as on 28th
June).

Going ahead we expect the systemic liquidity surplus in July to build further due to the following reasons:

Softer economic activity to limit outflows: Looking at past trends, currency in circulation is curtailed in this period due to
lean economic season. In four of the past five years, the month of July has seen a decline in currency in circulation due to
limited economic activity, partially due to the monsoons. As such, we see currency inflows in the banking system to
mitigate liquidity outflows in July. Some build up in the cash reserve requirement in July is likely to put marginal pressure
on liquidity. We expect the higher indicative state borrowings in July to be offset by the lower T-Bill auctions and higher T-
bill redemptions this month and keep the outflows in check.

Redemptions and steady expenditure to keep inflows in check: We see the inflows in the banking system to remain largely
around the same levels as June. Another large scheduled G-Sec redemption (INR 428.4 bn), along with steady coupon
inflows is likely to keep the inflows in check. We expect tax collections in July to be marginally lower relative to June
(quarter-end), but expect this to transpire into softer government expenditure and keep the net spending pattern largely
similar to that seen in June. As such, we expect a net inflow of around INR 300-400 bn to boost the systemic liquidity in
July to close to around the INR 1 trillion level.

Core liquidity to remain robust: The two OMO announcements in June and spot intervention by the RBI have pushed core
liquidity to a comfortable surplus of ~700 bn. If the currency in circulation were to see a decline this month as expected by
us, it would boost core liquidity further and not warrant additional impetus by the central bank in the form of OMO’s.
However, given the recent signaling of the central bank in maintaining adequate liquidity in the system, we do not rule out
the possibility of a single OMO of ~INR 125-150 bn in July.

We expect the OMOs to be more pronounced towards the months of August and September when outflows are expected
to increase due to larger tax collections and a pickup in currency in circulation. The liquidity review report due from the
RBI in mid-July is keenly anticipated as it would give cues about whether the liquidity stance and monetary policy stance
will be explicitly aligned in the future.

Bond and Rates market – on the edge

Government bond rally interrupted by fiscal and oil price concerns: Continued positive sentiment after the May 23 rd 2019
General Election outcome, announcement of two RBI OMOs (INR 275 bn in June) and another rate cut by the MPC in the
June policy, saw the 10-year G-sec breach the 7.00% threshold in June 2019 touching lows of 6.73% (on 20th June 2019).
This was also assisted by foreign flows into the debt market to the tune of ~USD 1.8 bn (from 24 th May 2019 – 25th June
2019). However, the last few trading sessions have seen a break to the rally on the back of 1) concerns of breach of fiscal
target of 3.4% set in the Interim Budget FY2020 2) report on RBI capital transfer to government shifted to July 16th 2019
and indications that the capital transfer from RBI to the government is likely to be insignificant 3) increase in oil prices on
account of geopolitical tensions and 4) risk on sentiment after G-20 summit and agreement between Saudi Arabia and
Russia to extend production cuts into early 2020. Going ahead, the Union Budget (5th July 2019) and the composition of
funding of the deficit and the liquidity report due from the RBI would be closely watched by the markets over the next few
weeks.

On the fiscal scenario, while we do not expect an increase in gross borrowings from the centre, fiscal adherence of 3.4%
would require expenditure rationalization, especially given that 1) tax revenues as expected in the FY2020 Interim Budget
look very ambitious 2) expected economic capital transfer from the RBI based on the recommendations of the Bimal Jalan
Committee has been postponed and would not be included in the Union Budget due on 5 th July, 2019. Rationalisation of
revenue expenditure could possibly be achieved by substantially reducing the budgeted food subsidy bill and aligning it
closer to the actual spend shown in the FY2019 fiscal math. Given the uncertainty over the fiscal and other key triggers, we
expect the 10-year benchmark to trade between 6.80 – 7.20% in the near term.

However, concerns on global growth along with accommodative monetary policy stance by global central banks including
the Federal Reserve, continued domestic growth slowdown, accompanied by benign headline inflation, and expectation of
further accommodation by the MPC, could support the bond market environment beyond the near term volatile triggers.
Positive sentiment in corporate bonds continues: Monetary policy guidance towards further accommodation and
expectations of maintenance of adequate system liquidity is supporting the corporate bond market segment. Corporate
bond spreads are very lucrative (except the NBFC, credit and structured space) and further liquidity management could
see an increased demand both at the short and the long end.

Global monetary policy driving the rally in global bond markets: The last FOMC meeting has raised market expectations of
accommodation by the Federal Reserve for 2019 with the Fed funds futures markets pricing in a 25 bps cut in the July Fed
meeting and ~ 65% probability of three and more cuts by the Fed till the end of this year (as on 27th June 2019). This has
led the US 10-year treasury yields breach the ~2.0% levels (on 25 th June 2019). Globally as well, 10-year Government
bond yields touched multi year lows (or touched record lows in the case of Australian and European benchmarks). This
was led by increase in dovish commentary by the ECB President along with other major central banks shift on rhetoric to
further easing, on account of uncertainties on the global trade front.

While the recent G-20 summit has appeased some of the concerns around the trade war and boosted sentiments, the
central stance around the accommodative monetary environment and global growth concerns remain in place. The
summit also saw Saudi Arabia and Russia coming on board over extending current production cuts of 1.2 million bpd,
which has increased the upside for oil prices and pose a threat to Indian bond prices. To this effect, the upcoming
economic data will be crucial in assessing the health of the global economy. An improvement in economic growth is likely
to boost oil prices further and also limit the need of an accommodative monetary environment, both of which are
detrimental for bond prices.

Chart: Indian Bond markets seeing relief

Source: Bloomberg, RBI, ICICI Bank Research

 Rates market overview
C h an ge over on e-
28-May-19 28-Ju n -19
In % mon th (bps)
US D Libor 3mth 2. 524 2. 320 -20. 39
US D Libor 6 mth 2. 541 2. 201 -34. 08
US T 2 yr 2. 124 1. 755 -36. 95
US T 5 yr 2. 069 1. 766 -30. 22
US T 10 yr 2. 266 2. 005 -26. 07
IN R 1 year 6. 359 6. 189 -17. 00
IN R 2 year 6. 545 6. 298 -24. 70
IN R 5 year 6. 909 6. 767 -14. 20
IN R 10 year 7. 148 6. 879 -26. 90
EUR 2 Y R -0. 648 -0. 758 -11. 00
EUR 10 Y R -0. 162 -0. 329 -16. 70
JPY 2 yr -0. 165 -0. 224 -5. 90
JPY 10 yr -0. 079 -0. 164 -8. 50
G BP 2 yr 0. 601 0. 620 1. 90
G BP 10 yr 0. 917 0. 833 -8. 40
AUD 2 yr 1. 128 0. 978 -15. 00
AUD 10 yr 1. 534 1. 322 -21. 20
C AD 2 yr 1. 535 1. 471 -6. 40
C AD 10 yr 1. 574 1. 464 -11. 00
Source: Bloomberg, ICICI Bank Research

In the rates market, OIS 5-year rates touched 6.18% levels (20th June 2019) while MIFOR 5 year rates moved around 6.5%
levels led by expectations of further accommodation by the MPC and maintenance of adequate system liquidity by the
central bank. However, in the forward markets contrary to market expectations the 12-month implied yields on rupee
forwards has surged to 2 year highs. This is widely believed to be on account of RBI operations where it has been buying
dollars to inject Rupee liquidity, in the spot market but has also been paying in the forward markets. While this has led to
an increase in implied yields, if the USD/INR continues to appreciate buoyed by portfolio inflows, positions in the forward
markets could increase, leading to some correction.

Chart: Indian Rates markets

Source: Bloomberg, RBI, ICICI Bank Research

 Currency – Dovish policy tones and recent trade truce bolster Rupee; fiscal and oil worries remain

Recalibration in the Fed’s moves has propped up the Rupee over June: The Indian Rupee has appreciated by ~1% against
the US Dollar over June 2019, with weakness in the US Dollar principally driving the move. The Dollar index has declined
by ~1.7% over June, which has largely been the outcome of recalibration of market expectations pertaining to the Federal
Reserve’s monetary policy trajectory. Escalating tensions on the trade front between the US and China over May-June this
year caused the Fed to reverse their earlier policy inclination to hike rates over 2019. The latest meeting held in June saw
Federal Open Market Committee (FOMC) members take an increasingly dovish tone, causing markets to anticipate easier
monetary policy going ahead. This dovish turn weighed on the Dollar, in turn bolstering the Rupee.

Latest trade truce will provide a relief cushion for the Rupee: The standoff between the US and China on trade related
issues seen over May-June 2019 saw a truce over the weekend at the Group of 20 nations’ meet in Japan. The two largest
economies decided to pursue talks on trade disagreements without imposition of further tariffs on each other. This
boosted sentiment for Emerging Market (EM) currencies over the weekend, with the Rupee gaining somewhat.

USD/INR Dollar Index

100
72

71
98

70
96
69

94
68
Feb-19

Jun-19
Jan-19

Mar-19

May-19
Apr-19
Apr-19

Jun-19
Feb-19

Mar-19
Jan-19

May-19

Source: Bloomberg, ICICI Bank Research

A return of debt inflows has marked the ongoing month: April-May 2019 had seen robust flows into Indian equity markets
by foreign portfolio investors, supported by election-based optimism and better-than-expected corporate results. June
2019 saw a return of debt flows into the Indian market, as bond yields softened after the Monetary Policy Committee’s
decision to cut rates in early June along with dovish guidance, as well as implications of a more dovish Fed. However, the
sustainability of these flows into the debt market over time will be dictated in part by the Final Budget (to be presented
next week), amid standing worries of an excessive supply of gilts, slowly rising inflation and fiscal concerns. Total FII
inflows over April-June 2019 has been USD 3.1 bn, with the month of June seeing inflows of USD 0.9 bn and USD 0.2 bn
in debt in equity markets respectively.

Balance of Payments to brighten: The latest balance of payments (BoP) print for Q4 FY2019 pleasantly surprised by
clocking a lower-than-expected current account deficit (8 quarter low) and a very healthy overall BoP surplus. This led to
the BoP clocking only a very mild deficit in FY2019, and the improvement seen over the course of last fiscal in the external
situation has been remarkable. We expect a further improvement to manifest this fiscal with the BoP surplus clocking
~USD 20 bn on the back of an improved current account and an increasingly healthy capital account. This may temper the
pace of depreciation in the Rupee. However, any significant global growth concern could weigh on the current account
deficit, which could impact the Rupee adversely.
Net portfolio flows to India
Current account balance Balance of Payments
(USD bn)
(US D bn) Debt Equity
10.0 15
10
8.0
5
6.0
0
4.0
-5
2.0
-10
0.0
-15
-2.0 -20
-4.0
Q4 FY2018

Q1 FY2019

Q2 FY2019

Q3 FY2019

Q4 FY2019

-6.0
Jun-19
Feb-19
Dec-18

Jan-19
Nov-18

Mar-19
Oct-18

May-19
Apr-19

Source: Bloomberg, ICICI Bank Research

However, despite the appreciation seen over June, the Rupee has underperformed other Emerging Market (EM)
currencies, with only the Chinese Renminbi lagging the Rupee’s performance. This is largely due to the fact that rising oil
prices, fiscal worries in light of the upcoming Budget, and increasing worries on the India-US trade front have tempered
investors’ penchant for the Rupee.
Performance of EM FX against the USD over June 2019
(%)
6.0

5.0

4.0

3.0

2.0

1.0

0.0

RUB
KRW
ZAR

IDR

CNY
THB

MYR
PHP

INR
TRY

MXN
ARS

BRL
Source: Bloomberg, ICICI Bank Research

Oil prices elevated again: The price of the Brent crude oil basket rose by ~3.6% over June, as Iran and the US have been
engaged in political face-off since mid-June. Additionally, Gulf OPEC producers decided in June to keep their July oil
production within their OPEC supply cut targets, signaling a reluctance to boost supply. This consistent increase in oil
prices could be tempered slightly by rising concerns about global growth, which would keep a lid on demand. The
upcoming meeting among OPEC and non-OPEC members on July 1-2 has seen preliminary signals from Russia, Saudi
Arabia and the UAE, who have indicated that they want to continue production curbs. India will keenly watch this meet to
gauge a direction for the price of its largest import item.

India-US trade disagreements have suddenly emerged: After intimating that the US would withdraw benefits to Indian
exports under the Generalised System of Preferences (GSP), the US went ahead with this decision in early June. India
exports nearly 1,937 products to the US under the GSP, which has a cumulative export value of ~USD 6 bn (India’s total
export to the US was ~USD 47.8 bn in FY2018). This is a substantial chunk of India’s total merchandise exports (~USD
340 bn), and may impact Indian exports fairly adversely on a cumulative basis. Following this, India raised customs duties
on 28 US goods in mid-June. Though Indian and American leaders have held communications recently regarding what the
US terms as “unacceptable” tariff hikes, the possibility of a rollback in the same looks muted at the moment. This
unexpected deterioration in trade relations has taken a toll on sentiment for the Indian currency.

Fiscal concerns to remain on the radar till the Budget is behind us: After the formation of the new Government, the
euphoria around the Election outcome has given way to concerns on what would be the Government’s pattern of
revenues and expenditure in a year where a growth slowdown has been much talked about. The Government will need to
fine tune a delicate balancing act between subdued revenue expectations, and burgeoning expenditure commitments to
peg the fiscal deficit at a reasonable level. Markets are currently on edge regarding the Budget outcome, and this is also
reflecting in the relative preference for other EM currencies.

Ranged trading in the Rupee looks likely in absence of shocks: The Rupee has seen swings within the 69-70 handles over
the last month, with pressures on either side largely balancing. The RBI’s forex reserves stand at a healthy ~USD 426 bn
as of 21st June, equivalent to around 10 months of imports, and sufficient ammunition to balance any untoward shock to
the domestic currency.

Global developments, will likely put pressure on the Rupee’s trajectory later in the year. Additionally, given the
Government’s intention to boost exports, it is unlikely for the Rupee to be encouraged to appreciate significantly,
compromising export competitiveness. Also, as latest available data shows, the RBI has continued to buy Dollars in the
spot market in April 2019 (USD 4.9 bn net purchase).

Given all these factors in play, the USD/INR is likely to trade in the range of ~68.50-70.50 in the near term. Triggers to
watch from the currency’s perspective are oil prices, the upcoming Budget and the panning out of the global trade
environment. The last should be studied from the point of view of its impact on the entire EM currency bunch, as well as
idiosyncratic impact on India due to the ongoing disagreements with the US . In the longer run, other concerns would
manifest more pronouncedly such as actual performance of the economy and markets, lack of resolution on the global
trade front, and the RBI’s penchant for intervention to stem bouts of strength. This could lead to the USD/INR displaying a
mild depreciation toward the ~71-72 range by the end of this fiscal.
ICICI Bank: ICICI Bank Towers, Bandra Kurla Complex, Mumbai- 400 051. Phone: (+91-22) 2653-1414
Treasury Research Group
Economics Research
Kamalika Das Economist (+91-22) 4008-1414 (ext 6280) kamalika.das@icicibank.com
Shivom Chakravarti Economist (+91-22) 4008-1414 (ext 6273) shivom.chakravarti@icicibank.com
Anushri Bansal Economist (+91-22) 4008-1414 (ext 6220) anushri.bansal@icicibank.com
Sumedha Dasgupta Economist (+91-22) 2653-1414 (ext. 7243) sumedha.dasgupta@icicibank.com
Ashray Ohri Economist (+91-22) 2653-1414 (ext. 7249) ashray.ohri@icicibank.com
Pradeep Kumar Economist (+91-22) 2653-1414 (ext. 6272) pradeep.kmr@icicibank.com
Yash Panjrath Economist (+91-22) 2653-1414 (ext. 8161) yash.panjrath@icicibank.com
Sparsh Chhabra Economist (+91-22) 2653-1414 (ext. 7309) sparsh.chhabra@icicibank.com
Priyanka Jeph Economist (+91-22) 2653-1414 (ext. 6943) priyanka.jeph@icicibank.com

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commercial and investment banking, financial advice, investment management, principal investment, hedging, financing and brokerage
activities. In the ordinary course of their various business activities, ICICI Bank and/or its affiliates may make or hold (on its own account, on
behalf of clients or in its capacity of investment adviser) a broad array of investments and actively trade debt and equity securities (or related
derivative securities) and financial instruments (including bank loans) for its own account and for the accounts of its clients and may at any
time hold long and short positions in such securities and instruments and enter into other transactions, including credit derivatives (such as
asset swaps, repackaging and credit default swaps) in relation thereto. Such transactions, investments and securities activities may involve
securities and instruments of the issuer or its affiliates or of other entities, and may be entered into at the same time or proximate to offers
and sales of securities or at other times in the secondary market and be carried out with counterparties that are also purchasers, holders or
sellers of securities or other clients of ICICI Bank or its affiliates. As a result, you should be aware that a conflict of interest may exist. In
accordance with the regulatory requirements and its own conflicts of interest policies, ICICI Bank has in place arrangements to manage
conflicts of interest that arise between itself and its clients and between its different clients. Where it does not consider that the
arrangements under its conflicts of interest policies are sufficient to manage a particular conflict, it will inform you of the nature of the
conflict so that you can decide how to proceed.

DISCLOSURE FOR RESIDENTS IN SINGAPORE

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The contents of this e-mail and/ or attachments do not take into account your personal circumstances. You must accordingly make their
own independent evaluation of the information contained herein and of the securities and consider your own investment objective,
financial situation and particular needs and seek your own financial, business, legal, tax and other advice regarding the appropriateness
of investing in any securities. ICICI Bank Limited (including its affiliates, and related corporations) (ICICI) do not provide any financial
advice, and is not your fiduciary or agent, in relation to the securities.

Please also note that ICICI is unable to exercise control or ensure or guarantee the integrity of/over the contents of the information
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