Mumbai: India’s 10-year bond yield rose from a two-month low on Wednesday as finance minister Pranab Mukherjee’s comments on the government’s widening fiscal deficit sparked concerns of more government borrowing at a time when the market had taken comfort over a likely halt to interest rate increases by the Reserve Bank of India (RBI). Bond prices and yields move in opposite directions.
The yield on the 8.79% benchmark bond due in 2021 fell to 8.56% the lowest level since 3 October, earlier in the day, but rose to 8.61% after Mukherjee told Parliament that slowing economic growth and a rising subsidy bill will have an impact on the deficit.
Finance minister Pranab Mukherjee. Photo: Pradeep Gaur/Mint
“Growth has come down, inflation is obstinately refusing to be moderated...and the consequences of that are going to have a reflection on the fiscal deficit,” Mukherjee said.
The government, in its February budget, estimated that the fiscal deficit would remain at 4.6% of gross domestic product (GDP), but slowing growth is likely to hit tax receipts and plans to divest stakes in state-run firms. Economists expect the fiscal deficit to cross 5.6% of GDP.
Bond market participants are no longer fearful of further interest rate hikes by RBI, which has raised rates 13 times since March 2010 to fight persistently high inflation, but are wary of excess government borrowing, said Sandeep Bagla, senior vice-president at ICICI Securities Primary Dealership Ltd.
“There is no negative news expected from the policy because RBI is likely to shift its focus towards growth. However, extra borrowing from the government side could lead to an increase in supply and hence hit demand for bonds,” Bagla said.
The yield on the 10-year bond had risen to a three-year high of 8.97% in November after crossing 9% in intra-day trade due to interest rate increases by RBI and the government’s decision to borrow an additional Rs 52,872 crore in the current fiscal, taking total borrowing in the year to Rs 4.7 trillion—the highest ever.
Ramit Bhasin, head of markets at Royal Bank of Scotland NV (RBS), India, said the rise in bond yields on Wednesday was temporary, mostly because of profit-taking.
“Yields rose after comments by the finance minister, but I think there was profit-taking after a very sharp rally (in prices),”
The 10-year yield fell 41 basis points (bps) from 8.97% to 8.56% between 14 November and 5 December. A basis point is one-hundredth of a percentage point.
Bhasin said there is still scope for yields to fall further.
“(In the) near term we see resistance at 8.5%, but over the next few months, we think bonds can rally to 8.25%. We are at the end of the rate cycle and with some fiscal discipline and FII (foreign institutional investors) buying, the undertone of the market will remain bullish,” he said.
Some expectations that RBI may actually cut the cash reserve ratio (CRR), or the amount of deposits banks have to set aside with RBI, had also helped sentiment. A section of the market expects a cut in CRR because of tight liquidity, which will get tighter next week following the outflow of advance tax for the current quarter that corporations will pay.
RBI has also started so-called open-market operations (OMOs) to buy back government securities in a bid to infuse liquidity in the cash-strapped banking system.
So far, RBI has bought back securities worth Rs 15,200 crore in two OMO auctions. On Monday, the central bank announced it will buy a further Rs 10,000 crore in an auction to be conducted on 8 December.
Dwijendra Srivastava, senior vice-president and head of fixed income at Sundaram Asset Management Co. Ltd, said he expects RBI to cut CRR from the current 6% to infuse liquidity in the system on 16 December, when the central bank meets for a mid-quarter policy review.
“RBI may choose to give some relief on 16 (December) just after the advance tax outflows, which will temporarily aggravate the liquidity situation,” he said.
Banks are borrowing close to Rs 1 trillion from RBI’s daily repo auctions at 8.5%, data from the central bank’s website shows.
Whether or not wholesale price inflation comes down will be crucial to a possible CRR cut, Srivastava said. Inflation has remained close to 10% despite a series of interest rate hikes by RBI. In October, inflation at 9.73% was 0.01% higher than 9.72% in September.
Srivastava said market expectations are for the inflation rate to come down to 9.1%, which will make it easier for the RBI to cut CRR.
Inflation has remained above 9% for 11 months in a row, much higher than RBI’s comfort level. The central bank expects it to come down to 7% by the fiscal year’s end.
“Inflation has surprised us so far, but a drop now could make it easier. A 25-bps cut in CRR will release Rs 15,000 crore in the system, which will also be in line with the global scenario where countries like Brazil, Australia and Thailand have cut rates,” Srivastava said.
Bhasin from RBS expects markets to price in a rate cut going forward, even though he expects policy action only in the second quarter of the next calendar year.
Slowing growth is likely to have an impact government funds as well.
“The government has just provided for Rs 16,000 crore for oil subsidy, but that bill is likely to be at around Rs 1.2 trillion. Besides, the government is also woefully short of its divestment target of Rs 40,000 crore, with only Rs 1,200 crore gathered so far; this will impact bond yields,” said S.P. Prabhu, head of debt funds at IDBI Federal Life Insurance Co Ltd.
Reuters contributed to this story.