The ongoing rally in government bonds might still have some steam left and bond traders expect the yield on the benchmark 10-year paper to drop to 7.5% by early February.
A combination of limited supply of government papers and aggressive buying by mutual and pension funds has been pushing the bond prices up. Yield on 10-year paper closed at 7.65% on Wednesday, down from Tuesday’s close of 7.68%. The yield touched 7.65%, the lowest since 11 January last year, on Tuesday, but closed higher. The yield on the same paper was close to 8% a month ago.
The rally gathered momentum after finance minister P. Chidambaram called for a 50 basis points cut in the lending and borrowing rates of banks last week. One basis point is 1/100th of a percentage point. Although bankers are unlikely to cut rates, bond dealers say that Reserve Bank of India’s (RBI) monetary tightening cycle may be over.
The central bank has raised its policy rates and the balance banks need to keep with it (called the cash reserve ratio, or CRR) several times in the past year to squeeze liquidity from the system and make money more expensive.
Bond traders say RBI may not go for another round of increase in banks’ CRR and could actually go slow on other liquidity tightening measures such as selling bonds under the market stabilization scheme (MSS). A wholesale inflation rate of 3.5% is also well below RBI’s comfort zone of 5% and this, dealers say, will encourage RBI to become less aggressive in mopping up liquidity from the system.
The bullishness in the bond market can also be attributed to the limited auctions left in 2007-08. RBI sold Rs5,000 crore of treasury bills on Wednesday. The government will sell Rs10,000 crore of bonds on 11 January as part of its annual borrowings programme. After this, Rs9,000 crore through another auction in February will complete the government’s Rs1.53 trillion borrowing programme for the financial year. The near completion of the Centre’s borrowing programme for the fiscal year and a late entry by pension and mutual funds (MFs) into the market is stoking demand for bonds and their prices. Indian bonds, with their high yields are also an attractive investment for foreign institutional investors (FIIs).
However, current regulations do not allow FIIs to invest more than $3.2 billion (Rs12,576 crore) in bonds.
“We expect the bond rally to continue for some time,” said Vikas Agarwal, an analyst with JPMorgan India Pvt. Ltd, the Indian arm of US bank JPMorgan Chase and Co.
“Central banks globally are likely to reduce policy rates further, boosting investor expectations of a softer rate regime in India. In addition, the demand-supply balance in the bond market has not been favourable for a while. Banks, MFs and insurance firms are likely to increase bond holdings during the next few mo-nths while the issuance pipeline for the remainder of the fiscal year is muted,” he said.
JPMorgan expects 10-year bond yield to fall to 7.5%. According to a senior trader with Union Bank of India, the bond market has already factored in the possibility of no further rate increase by RBI and bond prices are rising on sentiments of liquidity and limited supply. The trader asked not to be identified citing company policy. However, not everyone is convinced about the rally. In its weekly research report released on 7 January, Kotak Mahindra?Bank?Ltd?said?the?“smart fall in the yields witnessed in the last couple of weeks is unlikely to be repeated”.
“This is due to our feeling that the chances of a reduction in the policy rates by RBI at its Q3 monetary policy review on 29 January is low as inflationary expectations stay strong and M3 (money supply) remains above the target range. This will soon be factored in by the market,” the report said.