Vijay Kumar Gaba

JPM Bond Index inclusion (YES Bank)

JP Morgan included India's government bonds to its Government Bond Index-Emerging Markets Index (GBI-EM) and assigns the highest weight of 10% in the index. The inclusion will be phased over 10 months, starting from 28 June 2024 to 31 March 2025. We expect the cumulative flows to India to be ~ USD 30 bn, considering USD 23.6 bn flows through passive investments, topped up with investments from some active funds. The new entity on the demand side would be in addition to recent large investments by non-bank entities in the G-sec market, thereby potentially leading to demand exceeding supply of G-sec fresh issuances in any particular year. India 10Y bond yields could fall to 6.45%-6.55% in FY25, assuming a 75bps cut in the repo rate in FY25. However, we are not expecting any meaningful impact on USD/INR as RBI could be seen creating additional buffers to mitigate risks of larger potential outflows in the event of risk aversions.

India gets the inclusion nod: India’s inclusion in the JP Morgan’s Government Bond – Emerging Markets Index (GBI-EM) will be effective from 28th June 2024 and will be staggered over a 10-month period till 31st March 2025. 23 GoI bonds with a combined notional value of USD 330 bn are currently eligible for inclusion as they fall under “Fully Accessible Route” (FAR) for non-residents. On 30th March 2020, India introduced a separate channel called FAR to enable non-resident investor to invest in specified government securities without any ceiling limits.

USD 30 bn inflows expected in FY25: As of 31st August 2023, the AUM of GBI-EM fund stands at USD 236 bn. With India’s weightage at 10%, it would translate into a passive inflow of USD 23.6 bn in FY25. With inclusion of Indian government bonds in GBI-EM, we are also expecting inflows from some active funds interested in investing in India bonds. Cumulatively, we expect ~ USD 30 bn of potential inflows into India in FY25 because of the inclusion. FPI flows to India’s debt market has been tepid, and for FY24TD it stood at USD 4 bn compared to USD 18.9 bn inflows in the equity market.

Index inclusion seen overall a positive for GoI bonds: Expectations of an inclusion announcement had anyways been leading to the bond market participants ignoring higher global yields, higher crude oil prices and tightening liquidity by the RBI. A part of the news was thus anyways factored in by market participants even before the announcement came today.

Thus, the kneejerk reaction at the open whereby 10-year yields fell by 7 bps has been fully reversed and the benchmark paper traded at 7.18% at the time of writing. We think that H2FY24 G-sec yields are likely to be lower than in H1FY24. This is on a belief that 1) RBI is not likely to hike further yet express its tightening intention via guiding liquidity towards the neutral side, 2) Close to the end of global hiking cycle, 3) a lower net G-sec borrowing for H2FY24 at INR 3.72 trn compared to INR 5.93 trn in H1FY24.

The real impact of bond inclusion is likely to be felt in FY25 onwards. As mentioned above, USD 23.6 bn or (INR 1958.8 bn) of flows FPI inflows are expected over July 2024 to May 2025 (considering only the passive investments through the JPM Index route). We do some back of the envelope calculations here. Assuming a GFD/GDP at 5.5% for FY25 and a nominal GDP of 10.5% rise in FY25, the fiscal deficit is likely at ~ INR 17.9 tn. We assume 66% of this to be met by net market borrowings (~ INR 11.7 tn) and thus gross borrowings will be at INR 15.6 bn (redemptions at INR 3.89 tn). Thus, fresh flows into the G-sec market of 1.96 tn would be able to fund around 12% of fresh G-sec issuances in FY25. Presently, the share of FPIs to the total outstanding central government securities stands at only 1.6% (as of June 2023).

With global slowdown to manifest in FY25, we see a softer global interest rate cycle in FY25. We anticipate the RBI to cut the repo rate by 75 bps in FY25, starting from Q2FY25, almost coordinated with index related flows. Further, assuming a 70-80 bps tenor spread, 10-year G-secs could trade in the 6.45-6.55% range in FY25. The RBI could be resorting to some OMO sales in FY25 (explained later), and this could be a balancing factor against a sharper drop in yields.

USD/INR implication may be muted: Our FY24 USD/INR view remains unchanged at 83.50-84.00 by end-March 2024. For FY25, with the slowdown in the global economy expected to get deeper, India’s CAD/GDP is likely to be higher (assuming continued resilience for the domestic economy). Mindful that the FX inflows can reverse in adverse economic conditions, the RBI is likely to mop up a large part of the FX inflows and sterilize the same with OMO sales. USD/INR in FY25 will depend on a) extent of mop up of FX flows by the RBI, b) risk conditions in the global financial markets, and c) capital flows

Rupee Outlook for H2FY24 (CARE Ratings)

The Indian Rupee has recently breached the 83-level against the US Dollar, but its decline has been curtailed by interventions by the Reserve Bank of India (RBI) across various markets, including the spot, Non-Deliverable Forward (NDF), and futures markets.

In the coming second half of the fiscal year 2023-24, we anticipate the USD/INR exchange rate to fluctuate within the range of 82 to 84, gradually gravitating toward the lower boundary of this range. This projection marks a shift from our prior forecast of 81 to 83. The Federal Reserve's hawkish stance, communicated during the September meeting, is expected to sustain elevated yields in the US Treasury market and maintain strength in the US Dollar Index (DXY) in the short term. However, we anticipate US Treasury yields to moderate subsequently, as the Federal Reserve signals that interest rates have peaked, and as market participants re-evaluate their interest rate expectations when signs of weakness in the US economy become more pronounced in broader economic indicators.

The weakness in Chinese Yuan is expected to persist until China unveils substantial stimulus measures, and this is likely to exert downward pressure on the currencies of other emerging Asian markets. Tight supply conditions are projected to keep oil prices elevated in the near term; nonetheless, we anticipate a moderation in oil prices in the absence of substantial stimulus from China and as pace of economic growth in the United States begins to slow.

India's current account deficit is forecasted to remain manageable in FY24. Foreign Portfolio Investment (FPI) inflows are poised for recovery, driven by robust economic fundamentals and the eventual moderation of UST yields and the DXY. Furthermore, we anticipate that RBI interventions will persist, serving to mitigate rupee volatility and imported inflation.

Govt capex's momentum may moderate in 2HFY24 (ICRA)

The government's capital expenditure surged by a sharp 52% to Rs. 3.2 trillion during April to July FY2024 (31.7% of FY2024 BE) from Rs 2.1 trillion during April to July FY2023 (28.3% of FY2023 Prov.).

Based on the FY2024 BE (Rs 10.0 trillion), the pace of expansion in the GoI’s capex is likely to moderate to ~30% during Aug-Mar FY2024 (Rs 6.8 trillion in Aug-Mar FY2024 vs. Rs 5.3 trillion in Aug-Mar FY2023).

Historical data suggests that the centre's capex is generally lower in H2 vis-à-vis H1 in the pre-general election years, as seen in three of the last four such years between FY2004 and FY2019 (barring FY2009), likely on account of the model code of conduct, which is generally implemented during Q4.

‘King Coal’ is coming back (JM Financial)

As India is clocking all-time high peak power/energy demand growth (21%/15% YoY in Aug’23) and facing increasing shortage during non-solar hours (6-9GW in Aug’23), coal is ‘King’ again. Led by renewed demand supported by growth momentum in production (YTDFY24, 11% YoY growth), we estimate CIL to report 781/859/936MT of production during FY24E/25E/26E.

In addition to the growth in volume, prices of thermal coal in the international market are gradually picking due to fears of a gas crisis in Australia, China’s growing imports, declining stock at India’s power plants, and stringent safety inspection at China’s mines. Indonesia coal prices (5,900 GAR), which have corrected sharply (USD 218/ton in Mar’22 to USD 88/ton in Aug’23) are consolidating (USD 88-90/ton), indicating stability in e-auction prices. Amidst this, we met the management of Coal India to get a better sense of emerging scenarios.

Strong power demand: Monthly peak/energy power demand recorded 21%/15% YoY growth in Aug’23 with all-India peak demand touching 240GW on 1st Sep’23, breaching the previous high of 237/223GW in Aug’23/Jun’23. Increasing total energy shortage particularly during non-solar hours (6-9GW in Aug’23) is leading to renewed focus on coal-fired power generation. With 26.7GW of thermal power capacity under construction and another 25GW of projects under various stages of tendering, we expect demand for coal in power generation to consistently grow over the next decade.

Coal production to sustain growth: During YTDFY24, production at Coal India (CIL) stood at 281.3MT (11% YoY growth), sustaining the growth momentum. It supplied 587MT of coal to the power sector during FY23 and is targeting an offtake of 610MT in FY24. We estimate CIL to report 781/859/936 MT of production against the internal targets of 780/840/1,000MT for FY24E/25E/26E respectively. With recent initiatives such as Mine Developer and Operator (MDO), along with increasing power demand and the government’s renewed focus on higher thermal capacity additions, we expect CIL’s production to steadily increase and sustain the growth momentum in alignment with power demand.

International coal prices now consolidating: Prices of thermal coal in the international market are gradually picking due to fears of a gas crisis in Australia, China’s rising imports, declining stock at India’s power plants, and stringent safety inspection at China’s mines. Indonesia coal prices (5,900 GAR), which have corrected sharply (USD 218/ton in Mar’22 to USD 88/ton in Aug’23) are consolidating (USD 88-90/ton). Import prices of low-CV coal from Indonesia (3400 GAR) at Kandla have increased from INR 4,400/ton on 17th Aug’23 to INR 4,550/ton on 16th Sep’23. We also expect prices of coal in the international market to follow the crude oil price trend, mainly due to the role of substitution as seen in the past. Going forward, we expect coal prices to remain range-bound but the declining trajectory has been arrested.

Power Sector (CRISIL)

Power demand to grow 5.0-5.5% over the medium term:

·         Steady growth expected across categories

Discoms: ACS-ARR* gap on downward trajectory because of state support and better operating metrics; debt to continue to rise:

·         ~35% over fiscal 2023 estimates as payables fall

·         Operating performance of state discoms# improved with aggregate technical and commercial (AT&C) losses falling to an estimated ~15.1% last fiscal from 21.4% in fiscal 2021; to improve further to ~ 14% by fiscal 2025

·         Approved tariff hikes to improve viability of discoms, but implementation a key monitorable. Subsidy payout by states have been both timely and in full and are expected to remain so going forward

·         ACS-ARR gap to trend downward with expected tariff hikes and continuing subsidy support from state governments

·         Debt to rise as stretching payables no longer an option under New Electricity (LPS and other related matters) rules, 2022.

Gencos: PLFs of coal-based power plants to moderate in the near term on the back of scheduled capacity addition in fiscals 2024 and 2025, but to remain above 60% over the next five years

·         While capacity share of thermal power may go below 50%, generation mix to remain above 65% in the next five years

·         Domestic coal supply to the power sector to remain adequate at the current allocation level

·         Short-term markets to witness moderation in prices due to improving coal supply

·         Receivables seen at decadal low by end of this fiscal driven by regular monthly payments under LPS rules

·         Debt protection metrics of thermal independent power producer (IPPs)^ rated by CRISIL Ratings expected to sustain

Switch Trades (IIFL Securities)

From 44 ARAs that we have written for FY23, key themes are: 1) Weak consumption demand and sluggish volume growth in the consumer sector 2) strong industrial demand led by the government’s infra focus, and newer opportunities from RE, 5G, warehousing, power shortage & data centres. 3) Weakness in export-dependent sectors such as IT, Chemicals, US-focused Pharma, etc. 4) Margin hit due to raw-material cost spike – this has begun to reverse and margins will improve. 5) Strong companies maintaining investment intensity in difficult times, thereby strengthening positions.

Areas of sunshine...: Within Pharma, the India-focused names impressed given the better growth, higher margins, lower working capital (WC) and superior return metrics. With such a comparison of fundamentals between markets, we prefer Alkem with its US withdrawal to IPCA with new US foray. Telecom shone with the data-usage-driven ARPU uplift continuing, capex peaking, improving FCF and return profiles – Bharti is the top pick. Gas Utilities witnessed strong return & FCF profiles unaffected by fluctuating input prices and Power Utilities had tailwinds from impending power shortage. Industrial goods segments within Polycab (90% revenue share), Havells, Blue Star and Voltas did well; but B2C struggled – pricing environment stays weak. Trent registered spectacular growth in Zudio value fashion (and also Zara, where they aren’t investing much), and its psf sales growth of 20% YoY far outstripped the struggling DMart’s at 6.6%.

...and cloudy outlook: For Chemicals, pricing tailwinds are behind and ongoing large capex plans are getting deferred, due to weak international macro. We think weakness will persist given the weak performance of base metal prices in the recent months – SRF is the top pick. For IT, supply chain issues are behind but global slowdown and AI will haunt companies. In FY24, strong earnings growth for the domestic tyre-makers is already priced in. Once the margins peak, earnings growth will become lacklustre (FY25 onwards), mirroring sub-10% revenue growth.