Mumbai: Bonds rallied for the fourth day in a row after the euro zone crisis battered equity markets globally. The yield on 10-year bonds has dropped about half-a-percentage point since Friday, and the trend is expected to continue as the Greek debt crisis may force central banks around the world to defer interest rate increases.
The rally is also expected to be fed by surplus cash with domestic banks and a better-than-expected response to the telecom spectrum auction that will fill government coffers.
On Wednesday, the yield on the newly-issued 10-year bond closed at 7.61%, 7.2 basis points lower than Tuesday and about 48 basis points down from a week ago. Bond prices and yields move in opposite directions. A basis point is one-hundredth of a percentage point.
Graphic: Ahmed Raza Khan/Mint
During the same period, the Sensex fell 2.6% as investors booked profits from stocks and rushed to government debt.
Over the past week, the yield on 10-year US treasuries has dropped 23 basis points while the Dow Jones Industrial Average fell 1.6%.
“There can be a possible short-term shift from equity to bonds,” said Gopal Agarwal, head of equity at Mirae Asset Global Investments India Pvt. Ltd.
The increasing appetite for debt securities among mutual funds and foreign institutional investors (FIIs) is also one of the reasons behind the rally.
According to data available from capital markets regulator Securities and Exchange Board of India, mutual funds bought a net Rs5,774.8 crore in debt compared with Rs198.8 crore in equities in the last week of April. In the same period, FIIs bought Rs2,023.4 crore equity and Rs1,108.7 crore debt.
Dealers and analysts are, however, a bit unsure about declaring a wholehearted shift from equity to debt in India.
S. Rajendran, treasurer of Union Bank of India, said that although such a shift cannot be established, returns from bond markets even after accounting for hedging costs make them attractive for FIIs.
For instance, the yields on 10-year AAA-rated corporate bonds are at least 8.7%. This, along with recent talk of increasing FII limit in the debt market, higher interest rates and a stable exchange rate will be seen as positive factors for overseas investors, say debt market participants.
FIIs now can invest up to $15 billion (Rs67,350 crore) in corporate and sovereign debt.
“We may... not see (a) major sell-off (in bonds) until we live with the fears of sovereign defaults and contagion,” said R.K. Gurumurthy, head of treasury at ING Vysya Bank Ltd.
Greece, which has debt to the tune of 130% of its gross domestic product, has agreed to cut its deficit in return for a bailout by the European Union and International Monetary Fund. Still, investors are worried that the contagion may spread to other economies such as Portugal and Spain.
In a study analysing the effect of the debt crisis released on Wednesday, Standard and Poor’s credit analyst Elena Okorotchenko said, “The main channel of contagion is likely to be through higher funding costs”, but Asian sovereigns will be largely spared from the crisis because “among Asian sovereigns with relatively high debt burdens, Japan, India, and Taiwan borrow mostly domestically and are unlikely to experience the same volatility in investor sentiment as those borrowing externally”.
The heightened risk perception of the European debt problems also makes bond dealers almost certain that the central banks, including India’s, will not be aggressive in their rate-tightening stance, which is positive for bonds.
Gurumurthy also pointed out that the “the supply factor of bonds was overplayed”.
The government wants to borrow Rs4.57 trillion from the market to bridge its fiscal deficit in the current fiscal, which is targeted at 5.5% of GDP. Proceeds from the auction of third-generation spectrum licences are expected to cross Rs50,000 crore, higher than the government’s estimate of Rs35,000 crore.
“Bond auctions (can be expected) to sail through cheaply,” said G.A. Tadas, managing director of IDBI Gilts Ltd, a primary dealer that buys and sells government bonds. “The bullish cut-off at the last auction has set off the pace of the bond rally, which should continue for some more time to come unless there is a major upset like a hike in petrol prices.”
Higher petrol prices will increase inflation and put pressure on bond yields.
The Reserve Bank of India on Friday auctioned Rs5,000 crore of five-year paper and Rs2,000 crore of 22-year paper and the cut-off yields were lower than what the market expected. Both bonds were fully subscribed.
Another vital factor that is aiding the bond rally is the excess liquidity in the banking system due to low credit pickup in April, after a spurt at the end of the last fiscal.
The amount of money absorbed by the central bank in the past month averaged Rs60,900 crore daily against Rs32,900 crore in the previous 30 days, Bloomberg reported.
This is despite RBI raising the cash reserve requirement of the banks by a full percentage point since January, which sucked out about Rs42,000 crore of daily liquidity from the system. On Wednesday, banks parked Rs75,500 crore of their excess liquidity with the central bank.
Ashiwn Ramarathinam contributed to this story.