Pre Budget expectation and Local and global macro thoughts

by Ashhish Vaidya, Head of Treasury, DBS Bank India
1.   Fiscal Policy: Budget 2022
The Budget is likely to remain growth focused and hence the fiscal deficit is likely to remain high for next year. Sources quoted on newswires have stated 6.3% to 6.5% fiscal deficit for next year. Our expectation is that the revenues are likely to remain buoyant, hence the high fiscal deficit number would indicate higher expenditure. There is also the possibility of continued process of moving off balance sheet borrowing on NHAI etc to on balance sheet thus ensuring better transparency in the overall numbers. The higher borrowing numbers would likely push INR Government Securities yield higher with 10 year moving towards 6.80% by April 2022. The expectation is that we could see higher issuances in the longer end next year thus causing steepening of the curve.
2.   India Government Securities Index Inclusion
We expect to see the index inclusion announcement to come by Mar 2022. Though this is an additional demand coming up, we think this will only help offset the RBI OMO purchases that were seen last year. This would however, increase the inflows into the country and increase the RBI FX reserves kitty.
3.   RBI Policy Actions: INR Liquidity Absorption and Rate Hike
Economic growth seeing better traction indicated by better GST numbers, we expect RBI to increase INR liquidity absorption through larger amounts of VRRR and increase in Reverse Repo Rate through Jan to Apr this year thus taking o/n rates towards 4% from 3.35% currently. The initial action has been through VRRR as RBI was cautious on how the Omicron would play out. The VRRR gave RBI the flexibility to reverse their actions unlike a reverse repo hikes. However, with the severity of Omicron being muted, we expect RBI to hike Reverse Repo rate in Feb/ April policy and thus take short end INR rates higher.
Our expectation is that RBI would have the first hike in Repo Rate by 25 bps in either June or Aug policy. The headline inflation is expected to remain between 5.50% to 5.90% in the second half of the year with possible upside surprises. However, we do think that RBI policy action to be gradual and hence may not see more than two hikes this year in Repo Rate. We think the terminal repo rate of India has moved lower from 6% to 5% in this cycle.
Global macro thoughts -
4.   US Rate Hike Cycle, Global Liquidity and US China Policy Divergence
We have seen in the recent past that FED has come around to the view of persistent inflation and hence likely to see quicker rate lift off. Though the market expectation is of three rate hikes this year, we think only two rate hikes will materialize. However, market will continue with the extra hike pricing in the first half of the year as high inflation persists. The impact of his inflation is likely to have significant implication for US politics as this could lead to Democrats losing control of Senate after Nov midterm elections.
Though there has been rollback of various liquidity measures announced during the Covid period by the global central banks, our estimate is that global liquidity would continue to remain buoyant for the next two years and supportive for equity and other assets will remain.
In addition, we expect to continue to see divergence in US China Monetary Policy in this year. China is likely to see the growth slowing as well as continued migration of manufacturing from the country. This is in addition to changing demographics of their population will cause China Government and their Central Bank to take fiscal and monetary policy measures to support the economy.
5.   Crude Prices
With overall economic growth continuing the momentum along with increased travel along with the fact that this sector has not seen new investments n of the last couple of years due to the ESG move, we expect the demand for crude increase. The actual output increase from OPEC will be clearly behind the increase announced by OPEC due to the members ability to increase production. Also, unlike last time the Shale gas output is nowhere likely to pickup even at these crude price levels. Considering these, we expect crude prices to move to USD 100 per barrel during the year.
Lastly, the commodity price inflation will continue to provide headwinds to widespread global GDP growth.