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ICICI Securities Report
A key argument for the current rally in global equities is that the ‘discount rate’ has dipped sharply due to the unprecedented accommodative stance of global central banks in response to the Covid-19 pandemic, which has brought down the Rf (risk-free rate) while rising risk appetite is reducing the ERP (equity risk premium).
Dip in India’s Rf during Covid-19 episode is much lower compared to the U.S.
The Reserve Bank of India has cut policy repo rates by 140 basis points and cash reserve ratio (CRR) by 100 basis points year-to-date while unveiling additional liquidity measures (including long term repo operation for helping transmission of rates and operation twist for lowering the term premium).
Year-to-date, these measures have resulted in a sharper dip in yields at the shorter end (dip of approximately 200 basis points in less than one year government securities yields), but the measure of Rf (10-year bond) has dipped marginally by 50 basis points to approximately 6%.
Post global financial crisis (GFC) the drop in India’s 10-year bond yield was approximately 400 basis points in H2 CY08.
Sticky consumer price index (CPI) inflation at approximately 6.5% and sharp increase in fiscal deficit outlook has resulted in the 10-year bond yield remaining relatively high despite the rate cuts and liquidity measures by RBI.
To be sure, inflation as measured by wholesale price index (WPI) is currently is sharply lower as it was post-GFC when it represented the headline inflation number instead of the CPI post 2012.
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