September 2016 | srei
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September 2016

Highlights of RBI's Fourth Bi-monthly Monetary Policy Statement 2016-17

It has been decided to:

  • reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 6.5% to 6.25% with immediate effect.
  • Consequently, the reverse repo rate under the LAF stands adjusted to 5.75%, and the marginal standing facility (MSF) rate and the Bank Rate to 6.75%.

Indian Economy Review

Global and domestic institutions remain optimistic about the Indian economy

Global economic uncertainty does not seem to have had a major impact on the Indian economy. Major institutions worldwide continue to be optimistic about the country. According to the International Monetary Fund (IMF), the Indian economy is likely to grow strongly and the goods and services tax will provide a boost when it is rolled out. The Asian Development Bank has retained India's gross domestic product (GDP) growth forecast at 7.4% for the current fiscal and forecast the economy to grow at 7.8% in 2017-18. NITI Aayog Vice Chairman Arvind Panagariya said a good monsoon, reforms and timely decision-making at the Centre will push India's growth beyond 8% in subsequent quarters of the current fiscal. India's ranking in the Global Competitiveness Index (GCI) 2016-17 improved 16 spots to 39. Finance Minister Arun Jaitley said a 32-point jump in GCI in two years shows India is on its way to emerge as a major global player. He also said to ensure steady growth of the economy, there is a need for greater spending in rural India, improvement of infrastructure and revival of private sector investments.

Domestic GDP Growth

Domestic GDP Growth


Consumer prices decline in August

India's annual consumer price inflation eased to 5.05% in August from 6.07% in July owing to a sharp fall in food prices. However, the Wholesale Price Index (WPI)-based inflation rose to two-year high of 3.74% in August from 3.55% in July. Separately, the IMF said India's recent move to adopt a symmetrical inflation target should provide a robust institutional foundation for maintaining price stability.

Government marches towards its divestment target

The government has raised Rs 21,000 crore through stake sales and buybacks in April-September this year, against the fiscal year target of Rs 56,000 crore. It has also appointed merchant bankers to divest minority stakes held in listed and unlisted companies through the Specified Undertaking of the Unit Trust of India (SUUTI). Further, it is preparing a plan for strategic stake sales in 22 listed and unlisted public sector companies. It is also mulling a 5% stake sale in ONGC. The Ministry of Finance (MoF) is planning to launch the second tranche of central public sector enterprises (CPSE) exchange traded fund by the end of December. The government is weighing its options, including a public offering as part of a strategy to reduce its holding in the IDBI bank to below 50% from about 74% over a period of time.

The Cabinet took the following key decisions:

  • Approved the constitution of the Goods & Services Tax (GST) Council.
  • Approved advancing presentation of the annual budget by a month, scrapping an over nine-decade-old tradition of having a separate railway budget, and removing classifications for expenditure to make the exercise simpler.
  • Gave its nod to a consortium of IOC, Oil India and BPCL buying stakes in two Russian oilfields for $3.14 billion.
  • Cleared the 'strategic sale' of public sector undertaking (PSU) Bharat Pumps and Compressors.
  • Cleared a Rs 2,256 crore IT project Saksham of the Central Board of Excise and Customs (CBEC), which will help integrate CBEC's system with the GST network before the rollout in April next year.

Other important developments in the month

India signed a 7.8 billion euro deal with France to purchase new Rafale fighter jets. It ratified the landmark Paris climate deal at the United Nations. The government approved the exchange of duty concessions under the Asia Pacific Trade Agreement (APTA), a move aimed at enhancing commerce among six member countries including India and China. Britain set up a trade working group with India to prepare for a future deal following Britain's exit from the European Union.

The government decided to launch a GST outreach after December to explain the tax to stakeholders, and lift its awareness. It also released draft rules for registration, payment and invoices under the GST regime. The GST Council reached a consensus on three crucial issues - the threshold for exemption, the draft compensation formula and the issue of dual control. It also approved draft rules for the proposed levy and agreed to a refund mechanism for central and state tax holidays. CBEC released two more set of draft rules on filing of returns and claiming refunds under the GST regime.

Finance Minister Arun Jaitley launched a web portal that will enable pensioners to view their complete pension profile digitally by logging into The MoF revised criteria for recapitalisation of state-owned banks. The government decided to adopt a multi-pronged approach to deal with the problems arising out of sick, non-performing and loss-making PSUs under its administrative control. It also asked all public sector banks to approach the newly constituted overseeing committee to look at all their loans. A budget circular issued by the MoF said five-year plans will come to an end with the conclusion of the 12th Five-Year Plan on March 31, 2017.

The government's black money declaration scheme receives disclosures worth Rs 65,250 crore. Further, it unveiled a series of guidelines to regulate the direct selling industry. The government discontinued with the quarterly employment survey, instead started another more broad-based survey, which captures the employment market in India. It also came out with guidelines to help sick and loss-making PSUs sell their assets. The government plans to provide 'digital lockers' to keep documents such as driving licence or vehicle registration certificate. It has set the new domestic natural gas price at $2.5 per unit from October onwards.

Among regulatory developments

The RBI has asked the MoF to appoint a regulator for spot exchanges. The central bank directed Credit Information Companies (CICs) to provide one free full credit report, including score, once a year to individuals whose credit history is available with them. Telecom Regulatory Authority of India (TRAI) has proposed a regulatory framework for radio audience measurement to ensure a transparent and credible radio ratings system in India. It has also decided to issue show cause notice to errant telecom companies for failing to meet licence conditions.

Among key economic indicators released in the month

India's industrial production contracted 2.4% in July from a year earlier, mainly dragged down by lower production of capital goods and consumer non-durables, and compared to 1.95% growth in June. Core sector growth advanced 3.2% in August compared to a revised 3% growth in July. Fiscal deficit in the first five months of the current fiscal stood at Rs 4.08 lakh crore, which was 76.4% of budget estimates for 2016-17 against 66.5% of budget estimates over the corresponding period of the previous year. Trade deficit narrowed to $7.67 billion in August from $12.4 billion in the same month last year; exports fell by 0.3% on-year to $21.21 billion in August, while imports plunged 14.09% on-year to $29.19 billion in August. The country posted a CAD of $300 million, or 0.1% of GDP, in the April-June quarter, lower than $6.1 billion (12% of GDP) in the same quarter a year ago. The government's tax collections rose 23% in the first five months of FY17 to Rs 5.25 lakh crore from Rs 4.27 lakh crore in the corresponding period of the previous fiscal. India's external debt was $485.6 billion in March 2016, up 2.2% on-year owing to a rise in long-term debt, particularly non-resident Indian (NRI) deposits.

India's Nikkei/Markit Manufacturing Purchasing Managers Index (PMI) rose to 52.6 in August, the fastest pace in 15 months, from July's 51.8, while services PMI rose to 54.7 in August from 51.9 in July. SBI's Composite Index reading for September has come in at 50.2 (low growth) against the previous month's 52.7 (moderate growth). According to data on consumer sentiments by the BSE and the Centre for Monitoring Indian Economy (CMIE), consumer sentiment in the country fell 4.62% in August.

Indicators Current Previous
Monthly WPI Inflation 3.74% (Aug 2016) 3.55% (Jul 2016)
Industrial Growth -2.4% (Jul 2016) 1.95% (Jun 2016)
Exports $108.52bn (April - August 2016) $111.85bn (April - August 2015)
Imports $143.19bn (April - August 2016) $170.23bn (April - August 2015)
Trade Balance -$34.67bn (April - August 2016) -$58.38bn (April - August 2015)
Gross Tax Collections Rs 4,86,356cr (April-August 2016-17) Rs 3,99,085cr (April-August 2015-16)

IIP Growth

IIP Growth

  • India's industrial production contracted 2.4% in July from a year earlier, mainly dragged down by lower production of capital goods and consumer non-durables, and compared to 1.95% growth in June.

IIP-Core Sector Growth

Core IIP Growth

  • Core sector growth advanced 3.2% in August compared to a revised 3% growth in July.

Fiscal Deficit

Fiscal Deficit

  • Fiscal deficit in the first five months of the current fiscal stood at Rs 4.08 lakh crore, which was 76.4% of budget estimates for 2016-17 against 66.5% of budget estimates over the corresponding period of the previous year.

Global Economy Review

Global economic outlook remains pessimistic amid weak trade

The Organisation for Economic Cooperation and Development (OECD) has warned that the global economy is stuck in a low growth trap and believes the world's central banks are "pretty close" to the limits of their ability to stimulate economies. It has lowered the growth forecast for 2016 to 2.9% from 3% citing weak global trade. Harbouring similar pessimism, the World Trade Organisation (WTO) has forecast just 1.7% expansion in global trade in 2016, the slowest pace since the 2008 financial crisis and much lower than its estimate of 2.8% in April.

US Fed avoids rate hike; lowers economic outlook

The US Federal Reserve (Fed) left interest rates unchanged between 0.25% and 0.50% in its meeting but signalled it could tighten the monetary policy by the end of this year. The Fed lowered economic growth forecast for 2016 to 1.8% from 2% and its projection for interest rate at 0.6% by end-2016 from 0.9% forecast earlier. The GDP growth rate in Q2 was raised to 1.4% (annual) from the previously reported 1.1% growth and compared with 0.8% growth in Q1.

World GDP Growth

World GDP Growth

Major Indicators Current Previous Major Global Central Bank Latest Key Interest Rates
US GDP 1.4% Q2 2016 0.8% Q1 2016 US Fed Funds Rate 0.25-0.50%
US unemployment 5.0% Sep 2016 4.9% Aug 2016 Bank of England 0.25%
UK GDP 2.2% Q2 2016 1.9% Q1 2016 European Central Bank 0.00%
Euro Zone GDP 1.6% Q2 2016 1.7% Q1 2016 Japan Benchmark Rate -0.10%
Japan GDP 0.7% Q2 2016 1.9% Q1 2016    
China GDP 6.7% Q2 2016 6.7% Q1 2016    
Singapore's GDP 2.1% Q2 2016 2.1% Q1 2016    

Key economic indicators

  • The trade deficit declined to $39.5 billion in July from a revised $44.7 billion in June.
  • Retail sales declined 0.3% in August after an upwardly revised 0.1% gain in July.
  • Industrial output fell 0.4% in August after a downwardly revised 0.6% increase in July. Industrial capacity in use fell to 75.5% in August from 75.9% in July.
  • Annual Consumer Price Index (CPI) inflation rose 1.06% in August after 0.84% rise in July.
  • Nonfarm payrolls rose 156,000 in September, down from a gain of 167,000 jobs in August; the jobless rate rose to 5.0% in September compared to 4.9% in August.
  • Among housing indicators, new home sales fell 7.6% to a 609,000 annualised pace in August, from a revised 659,000 rate in the prior month while pending home sales fell by a seasonally adjusted 2.4% in August compared to July's decline of 1.2%.

ECB keeps interest rate unchanged; pessimistic on economic growth

The European Central Bank (ECB), too, kept interest rate unchanged in the September meeting but warned of uncertainty emanating from Brexit. The central bank's outlook for the region's economy turned slightly pessimistic as it lowered growth projection for 2017 and 2018 to 1.6% each from 1.7%. The ECB handed 45.3 billion euros to Eurozone lenders at zero interest rate in the second round of its programme to boost credit to the real economy. The bloc's GDP growth rate was confirmed at 1.6% annually in Q2 after growth of 1.7% in the previous quarter.

Key economic indicators

  • The current account surplus fell to 21.0 billion euro in July from 29.5 billion euro in June.
  • Annual inflation was 0.2% in August, stable compared with July.
  • Industrial production slipped 1.1% in July against a 0.8% rise in the previous month.
  • Retail sales rose 1.1% on-month and 2.9% on-year in July.
  • The unemployment rate was unchanged at 10.1% in July from the previous month.
  • The Markit's Composite PMI slipped to 52.6 in September, down from 52.9 in August, a 20-month low.

Bank of England maintains rates

The Bank of England (BoE) kept interest rate unchanged at 0.25% and decided to maintain the size of its corporate bonds purchases at up to 10 billion pounds and government bond purchases at 435 billion pounds. The BoE upgraded its growth forecast for Q3 to 0.3% from the earlier projection of 0.1%.

Key economic indicators

  • Public sector borrowing fell to 10.5 billion pounds in August, down from 11.5 billion pounds a year earlier.
  • Employment rose by 174,000 to a record high of 31.8 million in July. The ILO jobless rate was 4.9% for the quarter ended July, unchanged from the three months to June.
  • The trade deficit narrowed to 4.5 billion pounds in July from 5.6 billion pounds in June.
  • Industrial output gained 0.1% on-month in July after staying flat in June.
  • Retail sales declined 0.2% in August against July's 1.9% growth.
  • CPI was unchanged from the previous month at 0.6% in August.

China's economic growth forecast improves

The International Monetary Fund (IMF) said that China's economic transition has the potential to change the global outlook and the risks surrounding it. It said China's dwindling appetite for commodities and other imports may hurt world trade in the short term, but boosting domestic consumption could help in the long term. The Asian Development Bank (ADB) has raised its 2016 growth forecast for China marginally to 6.6% from 6.5% projected in March.

Key Economic Indicators

  • Retail sales rose 10.6% in August compared with a 10.2% jump in July.
  • Fixed assets investment remained unchanged at 8.1% over the first eight months of the year.
  • Industrial production rose 6.3% in August from a year earlier, compared with a 6% rise in July.
  • Exports fell 2.8% on-year in August following July's 4.4% drop, while imports rose 1.5% on-year in August, reversing a 12.5% fall in July, thereby resulting in a trade surplus of $52.05 billion, slightly below July's $52.31 billion.
  • The official manufacturing PMI rose to 50.4 in August compared with 49.9 in July, while non-manufacturing PMI edged down to 53.5 in August from 53.9 in July.

Bank of Japan rejigs monetary policy framework

The Bank of Japan (BoJ) overhauled its monetary policy framework by switching from the money printing programme to targeting interest rates. However, it kept the key interest rate steady at -0.1% and said that modification was aimed at resetting its stimulus program for a protracted battle to hit and then keep to its 2% inflation goal. Meanwhile, the government upgraded the GDP growth rate for Q2 to annualised 0.7% from 0.2% growth.

Key economic indicators

  • Japan posted a merchandise trade deficit of 18.711 billion yen in August, down from a 513.6 billion yen surplus in July.
  • The leading index fell to 100.0 in July from 100.6 in June. The coincident index rose slightly to 112.1 in July from 112.0 in the previous month.
  • The unemployment rate edged up 0.1% to 3.1% in August.
  • Retail sales fell 2.1% in August from a year earlier.
  • CPI fell 0.5% on-year decline in August, following a 0.4% drop in July.
  • Industrial production declined 0.4% in July after rising 2.3% in June.
  • The trade surplus narrowed in July to 613.9 billion yen from 763.6 billion yen in June, while current account surplus fell to 1.447 trillion yen in July from 1.648 trillion yen in June.

Singapore economic outlook turns dim

The quarterly survey of private economists by the Monetary Authority of Singapore (MAS) showed that Singapore's economy is expected to grow 1.8% in 2017 from the earlier projection of 2.1% growth. The growth forecast for 2016 was kept unchanged at 1.8%. Among key indicators, a) industrial production rose 0.1% from a year earlier in August after contracting 3.6% in July, and b) non-oil domestic exports (NODX) registered flat growth in August after falling 10.6% in July.

Domestic Fixed Income Review

Domestic G-sec Yield

6 Month LIBOR

The interbank call money rate moved near the repo rate of 6.50% for most of the month, mainly owing to comfortable liquidity conditions in the system. Intermittent fund infusion by the RBI in the form of repo auctions buoyed the rates further. However, some pressure was seen on the call rates after the RBI conducted reverse repo auctions at regular intervals to drain away excess funds. Outflows pertaining to advance tax payments also led to rise in the rates to a certain extent.

Government security prices (gilts) ended higher in the month with the yield of the newly-issued 10-year benchmark - the 6.97%, 2026 paper - falling to 6.81% on September 30, 2016 compared with 6.97% on September 02, 2016. The yield of the erstwhile 10-year benchmark bond - the 7.59%, 2026 paper - fell to 6.96% on September 30, 2016, compared with 7.11% on August 31, 2016. Expectations of a rate cut by the RBI in its policy meeting on October 4, 2016 buoyed sentiments. Bond prices also rose on expectations of additional open market bond purchase announcements by the central bank. A decline in latest domestic consumer inflation figures prompted further buying of gilts by market players. Prices were boosted after the US Federal Reserve (Fed) decided to keep interest rates on hold. In addition, gilts received support as the Fed's revised interest rate projections suggested a slower-than-expected pace of monetary tightening in the future. Other factors that positively influenced bond prices were a) sporadic gains in the rupee against the US dollar, b) weakness in US benchmark treasury yields and c) intermittent value buying, especially by state-owned banks. However, gains were cut short after India's strikes along the Line of Control raised concerns about escalating geopolitical tension. Intermittent pullback in the rupee and profit booking also restricted further rise in gilts.

Among major developments, the Centre plans to borrow a gross Rs 2.45 lakh crore in the second half of the fiscal with net market borrowings of Rs 1.77 lakh crore. The government expects to mobilise more than Rs 820 crore from the fifth tranche of Sovereign Gold Bond (SGB) scheme, and the next tranche will be launched with more attractive features before Diwali. The RBI will allow foreign portfolio investors (FPIs) to invest in securitised debt instruments issued by special purpose vehicles of financial institutions as well as unlisted debt securities of all public companies by this month-end. Securities and Exchange Board of India (Sebi) Chairman U K Sinha pitched for developing a unified BRICS - Brazil, Russia, India, China and South Africa - bond market for the benefit of all the member countries. Sebi allowed FPIs to trade directly in corporate bonds without needing any broker. Further, it is likely to make available a complete information repository for the primary bond markets from October. The capital market regulator has called for flexible pricing of municipal bonds to deepen this nascent market. It rejected requests of public sector banks to sell perpetual bonds to smaller investors citing potential risks of mis-selling.


Fixed Income Indicators

Rates & Liquidity

  30-Sep-16 1 Week Ago 1 Month Ago
Repo 6.50 6.50 6.50
Reverse Repo 6.00 6.00 6.00
CRR 4.00 4.00 4.00
LAF o/s Repo (Rscr) 7429 2964 10718
LAF o/s Rev Repo (Rscr) 46729 3034 8281

Overnight                                         Rate(%)

  30-Sep-16 1 Week Ago 1 Month Ago
Mibor 6.59 6.55 6.50
Call 6.45 6.55 6.30
CBLO 6.00 6.45 6.48
OIS 1Y 6.47 6.44 6.57
OIS 5Y 6.36 6.32 6.50

CDs                                                             Yield(%)

  30-Sep-16 1 Week Ago 1 Month Ago
1-Month 6.45 6.57 6.50
3-Month 6.45 6.57 6.60
6-Month 6.72 6.75 6.87
1-Year 6.94 7.14 7.20

CPs                                                   Yield(%)

  30-Sep-16 1 Week Ago 1 Month Ago
1-Month 6.62 6.83 6.70
3-Month 6.64 6.83 6.95
6-Month 7.20 7.35 7.60
1-Year 7.60 7.78 7.90

Short Term Bonds                                        Yield(%)

  30-Sep-16 1 Week Ago 1 Month Ago
1 Y G-Sec 6.68 6.67 6.83
1 Y AAA 7.25 7.28 7.33
1 Y AA 7.77 7.80 7.85
2 Y G-Sec 6.69 6.69 6.84
2 Y AAA 7.30 7.28 7.40
2 Y AA 7.77 7.75 7.87

Long Term Bonds                          Yield(%)

  30-Sep-16 1 Week Ago 1 Month Ago
5 Y G-Sec 6.87 6.84 7.02
5 Y AAA 7.41 7.40 7.50
5 Y AA 8.06 8.05 8.15
10 Y G-Sec 6.96 6.94 7.11
10 Y AAA 7.49 7.48 7.64
10 Y AA 8.31 8.30 8.46

Top 5 Graded G Secs                                   Yield(%)

  30-Sep-16 Previous Close 1 Month Ago
07.59 GS 2026 6.96 7.01 7.11
07.59 GS 2029 7.02 7.06 7.13
07.61 GS 2030 6.98 7.01 7.07
07.88 GS 2030 7.06 7.09 7.13
07.68 GS 2023 6.95 7.00 7.09


  30-Sep-16 1 Week Ago 1 Month Ago
USD/INR 66.62 66.60 67.02
EURO/INR 74.75 74.88 74.94
GBP/INR 86.42 86.47 87.69
100 JPY/INR 66.05 66.13 65.61
USD/EURO 0.89 0.89 0.89


10 Year G-sec movement


Corporate Bond Yield


Corporate AAA, AA Bond Spreads


Economic Events Calendar

October 11, 2016
  • US Monthly Budget Statement , September
  • Eurozone ZEW Survey (Economic Sentiment), October
  • Japan's Eco Watchers Survey: Current & Outlook, September
  • Japan's Machine Orders, August
  October 27, 2016
  • US Durable Goods Orders, September
  • US Pending Home Sales, September
  • Japan consumer price index, September
  • Japan Unemployment Rate, September
October 12, 2016
  • Eurozone Industrial Production, August
  • China Merchandise Trade Balance, September
  • US FOMC Meeting Minutes
  October 28, 2016
  • US GDP, Q3
  • US Employment Cost Index, Q3
  • US Consumer Sentiment, October
  • Eurozone Economic Sentiment, October
October 13, 2016
  • US Import and Export Prices, September
  • US Treasury Budget, September
  • Japan Producer Price Index, September
  • China Consumer Price Index, September
  • China Producer Price Index, September
  October 31, 2016
  • US Personal Income and Outlays, September
  • US Chicago PMI, October
  • US Dallas Fed Mfg Survey, October
  • China Manufacturing PMI, September
  • Bank of Japan Policy Announcement
  • Japan Manufacturing PMI, September
October 14, 2016
  • US Producer Price Index, September
  • US Retail Sales, September
  • US Business Inventories, August
  • US University of Michigan's Consumer Sentiment Index, October
  • Eurozone Merchandise trade balance, August
  • India's Wholesale Price Index Inflation, September
  November 1, 2016
  • US Motor Vehicle Sales, October
  • US Purchasing Managers'
  • US Manufacturing Index, October
  • US ISM manufacturing index, October
  • US Construction Spending, September
  • Eurozone Manufacturing PMI, October
  • UK CIPS/PMI Manufacturing Index, October
  • India Nikkei Manufacturing PMI, October
October 17, 2016
  • US Empire State Mfg Survey, October
  • US Industrial Production, September
  November 2, 2016
  • US FOMC Meeting Announcement
  • US ADP Employment Report, October
  • China's Caixin Services PMI, October
October 18, 2016
  • US Consumer Price Index, September
  • US Housing Market Index, October
  • UK Consumer Price Index, September
  • UK Producer Price Index, September
  • China GDP, Q3
  • China Industrial Production, September
  • China Retail Sales, September
  November 3, 2016
  • US ISM Non-Mfg Index, October
  • US Productivity and Costs, Q3 2016
  • US Factory Orders, September
  • Eurozone Unemployment Rate, October
  • Bank of England Announcement & Minutes
  • BoE Inflation Report
  • UK CIPS/PMI Services Index, October
  • Japan's Composite PMI, October
  • India's Nikkei Services PMI, October
October 19, 2016
  • US Housing Starts, September
  • US Fed's Beige Book
  • UK Labour Market Report, September
  • Japan All Industry Index, August
  November 4, 2016
  • US Employment Situation, October
  • US International Trade, September
  • Eurozone Composite PMI, October
  • Eurozone Producers Price Index, September
October 20, 2016
  • US Philadelphia Fed Business Outlook Survey, October
  • US Existing Home Sales, September
  • US Leading Indicators, September
  • European Central Bank Policy Announcement
  • UK Retail Sales, September
  • India's CPI for rural and farm labourers, September
  November 7, 2016
  • US Labor Market Conditions Index , October
  • US Consumer Credit, September
  • Eurozone Retail Sales, September
  • UK Merchandise Trade, September
  • China's Merchandise Trade Balance, October
October 21, 2016
  • Eurozone Consumer Confidence, October
  November 8, 2016
  • UK Industrial Production, September
  • China's Consumer Price Index, October
  • China's Producer Price Index, October
October 24, 2016
  • US Chicago Fed National Activity Index, September
  • US PMI Manufacturing Index, October
  • Eurozone Composite PMI, October
  November 9, 2016
  • US Wholesale Trade, September
October 25, 2016
  • US S&P/Case-Shiller home price index, August
  • US Consumer Confidence, October
  November 10, 2016
  • US Treasury Budget, October
  • Japan's Producer Price Index, October
October 26, 2016
  • US International Trade, August
  • US Purchasing Managers' Index, October
  • US New Home Sales, September

US Fixed Income Markets - Overview

US treasury prices dipped in September, with the yield of the 10 year bond settling at 1.61% on September 30 as against 1.57% on August 31. Prices fell after the European Central Bank kept the policy stance unchanged and did not announced additional stimulus measures. Demand for the bonds dented further on hawkish comments from some US Fed officials. Some encouraging US economic indicators and OPEC's decision to slash crude production also spurred bond selling. However safe haven demand was reignited after the US Federal Reserve kept the interest rates unchanged. Bond prices rose after the Fed lowered economic growth forecast for 2016 to 1.8% from 2% and lowered its projection for interest rate levels needed to stimulate the economy. Treasuries received additional momentum after the Bank of Japan abandoned its base money target and instead set a "yield curve control" under which it will buy long-term government bonds. Uncertainty about the upcoming US elections, geopolitical tensions between India and Pakistan, and fears over the financial health of Deutsche Bank provided further price support.

US 10 Year Govt. Bond Yield


Learning Centre - Masala Bonds

Compounding rewards patient and disciplined investors. Too often, investors pull out of their investments at the slightest hint of volatility, resulting in the realization of sub-optimal returns. For the compounding effect to kick in, investments have to be given time to grow. Let's take the example of a bond that offers 10% annual interest on an initial investment of Rs 1000.

The interest earned in the first year is 10% of Rs 1000, which is Rs 100. In the second year, the interest rate of 10% is applied on the first year balance of Rs 1,100. This gives an interest of Rs 110, or Rs 10 more than the interest earned in the first year. This extra amount is generated by earning 'interest on interest'. It may seem as though Rs 10 is a very small sum, but this amount scales up quickly over longer holding periods.

To calculate the value of the investment at the end of n years, we can use the formula:

Value of investment = initial investment * (1+interest)n

In the example above, the initial investment of Rs 1000 grows to Rs 6727.5 at the end of 20 years. In the 21st year, 10% interest is earned on Rs 6727.5 which works out to Rs 672.75. Here, Rs 100 corresponds to the initial interest earned in the first year, and Rs 572.75 is the interest on interest component. Notice that the interest on interest component has grown from Rs 10 in year 2 to Rs 572.75 in year 21.

Stay invested for longer, and the compounding effect becomes even more pronounced. Over 20 years, the investment grew over 6 times assuming 10% returns. Over 40 years, the investment balloons to over 45 times.

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