Near-term respite for bond market

Radhika Merwin BL Research Bureau | Updated on April 05, 2018

Risks to inflation and fiscal deficit, however, could play spoilsport



Indian bond markets that have been upbeat over the past week gained further after the RBI’s policy on Thursday. The yield on the 10-year G-Sec fell by a tidy 15 basis points as the RBI held rates and lowered its inflation forecast for the FY19 fiscal.

Bond markets have been volatile over the past six months, with concerns over inflation, tightening of global liquidity and worries over India’s fiscal slippages taking centre-stage. But thanks to the Centre lowering the borrowing programme for the first half of 2018-19, yields on 10-year G-Sec fell by 30 basis points last week.

While the RBI’s stance has given more reason for bond markets to cheer, the party may not sustain over the medium term.

The RBI is hopeful of the CPI inflation remaining in the range of 4.7-5.1 per cent during the first half and 4.4 per cent in the second half of this fiscal – it has also highlighted upside risks to its estimates. Revised MSP announced in the FY19 Union Budget, staggered impact of HRA revisions by various State governments, and fiscal slippage, as indicated by the RBI could play spoilsport.

More pressure

Also, the Centre’s borrowings that will now be back-ended for the current fiscal can add pressure to bond prices in the latter part of the year. The rally in bond markets could well be short-lived.

Since July-August, bond yields had been creeping up, even as the RBI lowered its key policy repo rate in its August policy last year. The increase in CPI inflation, from 3.58 per cent in October to 4.88 per cent in November, led by increase in food prices, had spooked the bond markets. Concerns over tightening of global liquidity had also kept bond markets on tenterhooks.

The Centre choosing to offer itself some leeway on the fiscal deficit front in the FY19 Budget also led to bond yields hardening. The yields on the 10-year government securities had risen by around 110 basis points to 7.56 per cent over the last six months until last week when the Centre lowered its borrowing plan for the first half of the fiscal. Yields on 10-year G-Secs cooled off by 30 basis points in the past week.

While the RBI’s sanguine outlook on inflation has added to the euphoria, bond investors should remain cautious.

For one, while the RBI has lowered its inflation forecast, upside risks in the form of HRA revisions, crude and fuel prices and sticky core inflation (excluding food and fuel) still persist. The RBI’s action will be data-driven, and hence, a rate hike cannot be ruled out altogether in 2018.

Two, as credit offtake picks up and liquidity dries up, banks may not have as much appetite for government bonds. Increase in the FPI limit in long-term government securities, could, however, offer some relief.

A sharp squeeze in global liquidity or higher than expected rate hikes in the US could always dampen Indian bond markets.

Published on April 05, 2018

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