Why has G-Sec yield moved in a narrow band?

The unexpected cut in policy repo rate by the RBI in February and hopes of further rate cuts have failed to enthuse the bond market. The 10-year G-Sec yield has been trading in a very narrow range of 7.3-7.4 per cent since February, despite widespread expectations of benign policy action by the central bank.

The RBI cutting its policy rate once again next week may not cheer the bond market much, which has already factored in rate cuts. A change in stance from neutral to accommodative can offer respite, but not enough to trigger a significant rally.

What remains a niggling worry for the bond market is the Centre’s fiscal expansion in the recent interim Budget 2019-20. The 24 per cent jump in gross market borrowings to ₹7.1 lakh crore in 2019-20 is no mean figure, which continues to keep bond markets on tenterhooks.

Fisc worry

The RBI’s previous rate easing cycle began in January 2015 when it lowered its key repo rate from 8 per cent to 6 per cent by August 2017. It started to hike rates from June 2018 onwards. But the up-cycle has been very short, as the RBI suddenly reversed stance and cut its repo rate by 25 bps in February this year.

While a favourable inflation reading had raised hopes of an easing policy by the RBI, delivering on these expected lines did not cheer the bond markets. For one, the RBI had cut its inflation projection sharply for the first half of 2019-20 from 3.8-4.2 per cent to 3.2-3.4 per cent in the February policy.

While low food inflation continues to drag overall CPI inflation, base effect wearing off, and sticky core inflation, are still keeping sceptics on guard. Importantly, fiscal worries have tempered expectations of a significant bond rally. After a gross borrowing of ₹5.7 lakh crore for 2018-19, the Centre had pegged ₹7.1 lakh crore gross borrowings for 2019-20; the sharp jump in borrowings have kept investors on tenterhooks.

The fiscal burden of States is also a concern. As of March 15, 2019, States’ gross borrowings stand at ₹4.5 lakh crore, up by ₹50,000 crore over last year.

Demand dynamics

PSBs sitting on large investments in government bonds were huge net sellers in them for the whole of 2018, net selling ₹76,541 crore. While PSBs have been net buyers in the first two months of 2019, they turned net sellers in March (as of March 27) to the tune of ₹12,343 crore.

Interestingly, mutual funds have been net sellers through the first three months of 2019. A large shift towards State Development Loans (SDLs) and corporate bonds are key reasons for this.

“Heavy supply of SDLs and corporate bonds in February and March led to spreads between these bonds and government bonds moving up to as high as 100 bps. The attractive yields on SDLs and corporate bonds have led to a shift towards these bonds. With supply in these bonds expected to moderate in the June and September quarters, spreads are expected to narrow,” explains Suyash Choudhary, head-fixed income at IDFC MF.

Foreign investors pulling out of the Indian bond market are only gradually evincing interest in recent weeks. They are still utilising only half of their limits for government bonds. While high interest rates have always attracted foreign investors to Indian bonds, uncertainty over rupee, heightened political risk due to the upcoming elections, and the Centre’s fiscal profligacy are dampeners.

Taking inflation into account, the real returns on Indian bonds are attractive at around 4.7 per cent. On a nominal basis, Indonesia offers high rates on its 10-year bonds at 7.6 per cent; the real returns work out to about 5 per cent.

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