Fixed Income Perspectives
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1. LIQUIDITY
• The Liquidity Eco-system
• The Process of Money Creation
• How to Measure Actual Banking System Liquidity
• Factors Affecting Near Term System Liquidity
2. GROWTH AND INFLATION
• How to Look at Demand Strength in Economy
• Broad Heads of WPI Inflation
3. FISCAL
• Broad Revenue and Expenditure Heads
• Why the Denominator (market GDP) is so important / How inflation helps fiscal deficit
4. EXTERNAL
• Broad Categories of Balance of Payments
5. YIELD CURVE AND TRIGGERS
FRAMEWORK

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THE LIQUIDITY ECO-SYSTEM
RBI
THE BANKING SYSTEM
Banks
MFs
Corporate
FIIs
PUBLIC
Repo
Forex Intervention
OMO, CRR
Reverse Repo
Forex Intervention
MSS, CRR
GOVERNMENT
Government Spending
Auctions
WMA Overdraft, Dividend Payout
WMA Surplus
Net Rise in Currency With Public
Why has system liquidity been progressively shrinking over last few
years?

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THE PROCESS OF MONEY CREATION
Sources of Reserve Money Components of Reserve Money
Net RBI Credit to Govt : 37%
RBI Credit to Banks and Commercial Sector: 1%
Net Forex Assets of RBI : 100%
Govt’s Currency Liabilities to Public: 1%
(-) Net Non-Monetary Liabilities of RBI: 38%
Currency in Circulation: 72%
Bankers’ Deposit with RBI: 28%
Other Deposits with RBI : 0%
Why has the RBI had to resort to doing OMOs over the last few years?

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HOW TO MEASURE ACTUAL BANKING SYSTEM LIQUIDITY
Does daily repo balance give an accurate picture of system liquidity?
Actual liquidity is measured as the difference between system cash and
average daily balance to be maintained

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1. Positive Drivers
• Forex Intervention by RBI (buy dollars, sell rupees)
• OMOs
• CRR cut
• Government Spending
2. Negative Drivers
• Forex Intervention by RBI (buy rupees, sell dollars)
• MSS / Bond sale to market
• CRR hike
• Net Rise in Currency with Public
• Government accumulating WMA surplus (tax collections, market borrowing etc)
• Deposit Growth ? (increases CRR requirement
FACTORS AFFECTING NEAR TERM SYSTEM LIQUIDITY

WHAT CAN BE THE LIQUIDITY PROJECTION FOR FY13 IN
ABSENCE OF FURTHER RBI ACTION?
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AGGREGATE DEMAND
AD = C + I +G + X - M
0.05
0.055
0.06
0.065
0.07
0.075
0.08
0.085
0.09
0
0.02
0.04
0.06
0.08
0.1
0.12
0.14
0.16
0.18
0.2
0.22
0.24
31-Mar-09
30-Jun-09
30-Sep-09
31-Dec-09
31-Mar-10
30-Jun-10
30-Sep-10
31-Dec-10
31-Mar-11
30-Jun-11
30-Sep-11
KEY COMPONENTS OF AGGREGATE DEMAND (3QMA YOY%)
GOVT EXPENDITURE GROSS CAPITAL FORMATION PVT CONSUMPTION
Private consumption has
been anchor to growth
but is now slowing
Government expenditure
has also slowed and
given fiscal constraint is
unlikely to rise in year
ahead
Slower capital formation
lowers potential GDP
growth rate. This may
also cause inflation to
resurge sooner once
growth rebounds

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INFLATION
What Is Base Effect?
WPI Index
31-Jan-10 135.2
28-Feb-10 135.2
31-Mar-10 136.3
30-Apr-10 138.6
31-May-10 139.1
30-Jun-10 139.8
31-Jul-10 141.0
31-Aug-10 141.1
30-Sep-10 142.0
31-Oct-10 142.9
30-Nov-10 143.8
31-Dec-10 146.0
WPI Index
31-Jan-11 148.0
28-Feb-11 148.1
31-Mar-11 149.5
30-Apr-11 152.1
31-May-11 152.4
30-Jun-11 153.1
31-Jul-11 154.2
31-Aug-11 154.9
30-Sep-11 156.2
31-Oct-11 157.0
30-Nov-11 156.9
31-Dec-11 156.9
YOY
(Inflation)
9.47%
9.54%
9.68%
9.74%
9.56%
9.51%
9.36%
9.78%
10.00%
9.87%
9.11%
7.47%
WPI Index
(Hypothetical)
31-Jan-12 156.9
29-Feb-12 156.9
31-Mar-12 156.9
30-Apr-12 156.9
31-May-12 156.9
30-Jun-12 156.9
31-Jul-12 156.9
31-Aug-12 156.9
30-Sep-12 156.9
31-Oct-12 156.9
30-Nov-12 156.9
31-Dec-12 156.9
YOY
(Inflation)
6.01%
5.94%
4.95%
3.16%
2.95%
2.48%
1.75%
1.29%
0.45%
-0.06%
0.00%
0.00%

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INFLATION
What Is Core Inflation?
BEVERAGES 1.4
TEXTILES 9.8
WOOD PRODUCTS 0.2
PAPER PRODUCTS 2
LEATHER PRODUCTS 1
RUBBER / PLASTIC 2.4
CHEMICAL PRODUCTS 11.9
NON METAL 2.5
BASIC METALS 8.3
MACHINE TOOLS 8.4
TRANSPORT EQUIPMENT 4.3
Heavily
influenced
by
commodity
prices
Difficult to assess demand pressures in
absence of comprehensive CPI (RBI tracks
‘pricing power’ with corporates)

HOW DEEP CAN THE INTEREST RATE CUT CYCLE BE
ASSUMING GLOBAL COMMODITY PRICES REMAIN WHERE THEY
ARE?
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FISCAL

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- Fiscal deficit is expressed as a %age of market GDP
- Government borrowing may be rising even with falling fiscal deficit owing to rising
denominator
- Higher inflation may help fiscal deficit (nominal revenue growth as well as
denominator effect)
THE OPTICS OF FISCAL DEFICIT

WHAT COULD FISCAL DEFICIT BE IN YEAR AHEAD AT CURRENT
LEVEL OF COMMODITY PRICES?
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BROAD CATEGORIES OF BOP
Net
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A. CURRENT ACCOUNT
I. MERCHANDISE -1,30,593
II. INVISIBLES (a+b+c) 84,647
a) Services 48,816
b) Transfers 53,140
c) Income -17,309
Total Current Account (I+II) -45,945
B. CAPITAL ACCOUNT
1. Foreign Investment (a+b) 39,652
a) Foreign Direct Investment (i+ii) 9,360
b) Portfolio Investment 30,293
ii) Abroad -1,179
2. Loans (a+b+c) 28,437
a) External Assistance 4,941
b) Commercial Borrowings 12,506
3. Banking Capital (a+b) 4,962
a) Commercial Banks 4,433
b) Others 529
4. Rupee Debt Service -68
5. Other Capital -10,994
Total Capital Account (1 to 5) 61,989
C. Errors & Omissions -2,993
D.
Overall Balance (Total Current Account, Capital Account
and Errors & Omissions (A+B+C))
13,050
E. Monetary Movements (i+ii) -13,050
i) I.M.F. –
ii) Foreign Exchange Reserves (Increase - / Decrease +) -13,050
of which: SDR allocation –
No. 41: India’s Overall Balance of Payments
(US$ million)
Item
2010-11
Possible pressure-points
Deteriorating trade balance on
slowing export growth (whereas
commodity imports remain high)
Portfolio investments have dried
up in last year. Partly
compensated by debt flows
(further ceiling relaxations for
FII Debt?)
Rupee volatility and challenging
external markets may make
ECBs less lucrative

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YIELD CURVE AND TRIGGERS
1. Why Does Our Yield Curve Invert
• Shorter end has no ‘natural’ buyers and moves freely in
response to liquidity, C/D ratio, and expected RBI stance
• Long end has ‘artificial’ anchor from SLR demand and PF /
Insurers.
• Over recent years RBI’s OMO s have given additional support
to long end rates
2. What Can Cause the Inversion to Correct
• Better liquidity, falling C/D ratios, change in RBI stance
• Rise in net supply at long end
Basis our analysis of the above triggers, we think the yield curve will
remain inverted till March. However, starting April the curve should
incrementally start to steepen

WHERE WOULD OPTIMAL RISK VERSUS REWARD BE IN AN
ENVIRONMENT OF CURVE STEEPENING
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18
Government Borrowings

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20
Inflation - India

THANK YOU
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