Fixed Income Outlook January 2022

Outlook 2022: The Long Road to Higher Rates

The fears of rising Omicron and a dovish MPC outcome led to range-bound trading across the curve. However, in the latter half of December, additional VRRR auctions and devolvement of G-secs on PDs led to a sell-off in the bond market with the 10Y benchmark touching intraday highs of 6.49%. RBI responded with a rejection of the bids in the last weekly G-sec auction, signaling its discomfort with the surge in yields.

The 10-year benchmark yield traded in the range of 6.35% and 6.48% and closed 11 bps lower at 6.45%, compared to last month’s close of 6.34%. 5-year OIS 8bps higher at 5.37%, 3-year OIS 17 bps higher at 5.14%, 1-year OIS 13bps higher at 4.34%, CD 1-year 10bps up at 4.43%, 6-month 15bps up at 4.13%, 3-month CD 10bps at 3.63%. Corp bond 1yr 20bps 4.64, 3yr 5.5 15bps up, 5yr 6.06, 13bps up, 10yr 5bps up

Banking system Liquidity in the month of December averaged around Rs. 7.38 trillion which was lower from the previous month’s average of Rs. 7.55 trillion (Rev Repo-Repo-Marginal Standing Facility-Standing Liquidity Facility + term repo/re-repo).

INR traded in the range of 76.23/$ to 74.34/$ and closed at 74.34$ in December vs 75.17/$ in November. India’s forex reserves dropped to $635 bn in December as compared to $638 bn a month before.

Domestic Macro Factors

Industrial Production

The Index of Industrial Production (IIP) growth for October largely remained unchanged at 3.2% y-o-y from 3.3% seen in September, this was also lower than market expectation of 3.7% growth. This was largely due to base effect and in fact on a month-on-month basis, the index grew by 4.3% after contracting for two months. Mining, Electricity, and manufacturing respectively printed at 15.4%, -0.4% and 3.4% m-o-m in October.

In terms of use-based classification, basic goods sector grew by 9% y-o-y in October vs. 4.60% y-o-y in September. Consumer non-durables sector grew by 0.5% y-o-y in October vs. 0.2% y-o-y in September. The capital goods sector growth dropped to -1.1% y-o-y in October vs. 2.4% y-o-y in September. The PMI number improved in December as Manufacturing PMI came at 57.6 compared to 55.9 for November. Services PMI moderated marginally to 55.5 in December compared to 58.1 in November.

External Account

India’s external trade deficit remained high at $22 bn in December marginally lower compared to $22.9 bn in November. This was mainly due to higher imports despite robust exports. Imports for the month of December rose to all time high of $59.3 bn as compared to $53 bn in November. On y-o-y basis the Imports rose by 38.1% in December vs. 56.6% in November. Oil imports were $15.9 bn in December vs. $14.7 bn in November and gold imports rose to $4.6 bn in December vs. $4.2 bn November. The non-oil non-gold imports rose sharply to $38.8 bn in December, $4 bn higher than last month. Exports rose sharply to $37.3 bn in December as compared $30 bn in November. On a y-o-y basis, exports grew by 37% y-o-y in December vs. 27.2% in November. Within Exports, non-oil exports increased to $31.7 bn in December vs. $26.2 bn in November. Oil exports too rose to $5.6 bn in December as compared to $3.8 bn in November.

Current Account & Balance of Payment

India’s Current account balance for the second quarter of FY21-22 showed deficit of $9.6bn (-1.3% of GDP) compared to a surplus of $6.5 bn seen in previous quarter. The current account deficit was driven by higher trade deficit and investment income outflow. Trade deficit rose to 5.9% of GDP v/s 4.4% deficit in Q1. This was led by higher imports, reflecting higher commodity prices and domestic demand recovery. Despite the wider current account deficit, Balance of Payments (BoP) surplus remained robust at US$31.2bn, partly due to one-time SDR allocation of US$17.9bn by the International Monetary Fund. Save for this, BoP surplus would be much lower at US$13.3bn compared to US$31.9bn in the previous quarter.

Tax Revenue

The Goods and Services Tax collections remained robust and for December and came at Rs. 1.30 lakh crores, almost same as November. This includes Central GST of Rs. 22,578 crores, State GST of Rs. 28,658 crores, Integrated GST of Rs. 69,155 crores and Cess of Rs. 9,389 crores.

Direct Tax collections also remained strong, advance tax for both personal and corporate income taxes in 3QFY22 grew by 90% y/y to Rs.941bn. Nearly 60% of this accounted for advance corporate tax.


Headline CPI inflation for November increased to 4.9% y-o-y vs. 4.5% y-o-y in October. This was a tad lower than the market expectation of 5.1%. This uptick in inflation was due to higher food, higher core inflation and unfavorable base. The food and beverages combined inflation increased to 2.6% in November vs. 1.8% in October. Core CPI Inflation (CPI ex-food & beverages, fuel) rose to 6.2% y-o-y in November vs. 5.9% y-o-y in October. The inflation for fuels and lighting articles, helped by cut in excise duty on petrol and diesel, dropped to 13.3% y-o-y in November vs. 14.3% y-o-y in October.

WPI inflation rose to 14.2% compared to 12.5% seen in October. This was significantly higher than market expectation of 12%. Food inflation inched up to 7.5% y-o-y in November as compared to 4.1% y-o-y in October. Fuel and power inflation accelerated to 39.8% y-o-y in November vs. 37.2% y-o-y in October. Manufactured goods inflation remained steady at 12.3% in November vs. 11.9% in October.


In the US, the Fed doubled monthly bond tapering to USD 30 billion starting January and the dot-plot also mentioned three quarter-point interest-rate increases in 2022, three in 2023 and two more in 2024. US Federal Reserve Chair noted that economic activity is on track to expand at a robust pace, adding however, that the Omicron variant poses risks to the outlook.

Later the minutes from the December US Fed policy meeting highlighted the concern about the higher inflation that appears to be persisting, alongside global supply bottlenecks “well into” 2022. It pointed out that given the outlook for the economy, labor market, and inflation, it may become warranted to increase the federal funds rate at a faster pace than anticipated earlier. Further, it could be appropriate to begin to reduce the size of the Fed’s balance sheet relatively soon after beginning interest rate hikes FOMC is coming around the view that the economy is ready for a broad-based removal of monetary accommodation and the omicron variant is unlikely to slow it down.

The European Central Bank confirmed that the Pandemic Emergency Purchases Program (PEPP) would end by March 2022 but will remain an option if required in the future. The ECB also increased the size of its traditional Asset Purchase Program (APP) over Q22022 and Q32022.However, the only hawkish surprise from the ECB came from the upward revisions that were made to the inflation projections. In contrast to the ECB, the Bank of England’s MPC surprised markets by announcing a rate hike of 15bps by an 8-1 vote. The main reason behind the hike was the step-up in inflation concerns.

The common concern for all three central banks who recently turned hawkish is the uncertainty that Omicron poses for the outlook. However, there is a realization that the overall hit on GDP due to each subsequent wave of the virus has been diminishing therefore right now focus is on the inflation outlook especially when labor market outlook is robust.

By the end of last month, Covid Cases which had been rising globally started to rise significantly in India as well. The only solace is that till now studies reveal that the current Omicron variant is less severe than the Delta variant. While globally number of new cases have doubled in last three months the number of deaths has remained relatively stable. In India till now despite Omicron risks the policy restrictions have not posed any severe impact on mobility so far. This could result in continuation of normalization in services sector, albeit slow, in addition to recovery in industrial sector. Yet India remains at risk as large number population is still not fully vaccinated and this may have some influence on MPC’s decision making, may push MPC to wait and watch at least for next policy even when all indications have been that we are nearing faster policy normalization.

The Headline inflation going ahead will find the base effect less favorable and the period of aggravated inflation during second wave lockdowns in 2021 will come into time series calculation only from May 2021. Fundamentally, we have seen lesser seasonal drop in food inflation in December and Crude prices too have been higher. Telecom firms have raised their tariffs to strengthen their balance sheets and there is a risk of higher broadband charges. FMCG have announced a price hikes and other consumer companies are looking to do so. In addition, post third wave the full reopening will continue to add to services price inflation.

As of now, the Monetary Policy focus is on ensuring broadening of growth recovery. Hence, repo rate hike may be sometime away in 2022. Till now the RBI has been able to increase the cost of funds absorbed at reverse repo window and in a limited way at short end of curve (as Credit Growth remains weak) without increasing the reverse repo rate. This has been achieved by increasing the quantum of VRRR. Therefore, the next policy step is likely to be a reverse repo rate hike provided Covid-19 uncertainty reduces.

We believe the economic impact of the new strain should be limited than the earlier waves and growth momentum generated now will continue resulting in eventual repo rate rise in coming quarters causing the yield curve to bear flatten (as we expect the shorter-term rates to rise more than the longer-term rates). In this backdrop, investors with investment horizons of up to 24 months can stay invested in moderate duration strategies (low duration, short duration, and medium duration), while for cash management depending on appetite one can invest in overnight, liquid, or ultra-short funds. Investors with longer horizons of 3 years and above can match duration for indexation benefit of put monies in laddered strategies or roll down strategies.