Mumbai: In a sign that the domestic debt market is becoming increasingly sensitive to developments beyond the nation’s borders, the 10-year Indian government bond mimicked the movements of its US counterpart last month.
Typically, and unlike equity markets, movements in the debt market depend more on domestic developments such as government and central bank policy moves and economic data releases than on global cues.
In May, yields on both Indian and US 10-year treasury paper fell substantially. The yield on US paper fell to 7.90% and yield on the Indian security dropped to 6.6%. Bond prices and yields move in opposite direction.
In absolute terms, yields dropped 30 basis points and 53 basis points, respectively. One basis point is one-hundredth of a percentage point.
According to debt market participants, the close tracking of movements in the 10-year US treasury by its Indian counterpart showed the linkages India has developed with global markets. As a result, say bond dealers, all financial markets have reason to track developments overseas.
“US treasury movement has always been a factor but now the linkage has increased and the correlation is higher,” said Arvind Sampath, director (rates trading) at Standard Chartered Bank.
On Wednesday, the yield on the domestic 10-year bond closed at 7.506%, down from 7.515% on Tuesday.
Unlike equity markets, where swings often can be attributed to fund flows from foreign institutional investors (FIIs), there is no clear and direct link between domestic and overseas debt markets.
The FII limit in the Indian debt market is only $20 billion—$5 billion in government debt and $15 billion in corporate bonds. Already, FIIs, which typically do not pull back from debt instruments, have reached that cap.
Nonetheless, a close linkage exists between domestic equity markets and debt markets. Whenever equity markets fall, investors tend to rush to more secure debt instruments.
Similarly, in times of a crisis, such as the one over European debt problems, global investors tend to withdraw money from risky emerging markets and park them in US treasuries, considered the safest bet.
“US treasuries are a proxy for global growth and thus that of global uncertainty,” said Sampath.
That those uncertainties have reached Indian shores was confirmed after Reserve Bank of India (RBI) governor D. Subbarao said on Tuesday that monetary policy decisions will be taken keeping in mind both domestic and external developments.
“Nowadays global linkages are always there in the back of our minds. Traders have become cautious and following a wait-and-watch approach,” said Prashant Patankar, vice president at STCI Primary Dealership Ltd.
According to him, safe haven investments in US treasuries and other dollar assets push up the dollar index and cause a sell-off in the commodities market. This, in turn, pulls down prices of essential commodities including oil. India imports 70% of its oil requirements.
Lower oil prices mean lower inflation, which gives pause to aggressive rate increases by the central bank. Completing the circle, any interest rate action has a direct bearing on the bond market. The extent of the risk aversion phenomenon can be gauged from movements in the US bond market.
“Nowadays linkages are very high because of the fund flows. When you don’t have a clear domestic cue, you follow the international directions.... The global cues are now much more stronger than the domestic cues,” said Jayesh Mehta, managing director and country treasurer at Bank of America.
He added that now RBI will also have to raise rates in a calibrated manner and in tandem with global central banks
“If you are trying to track global sentiment, the best benchmark is US treasury,” Mehta said. “All global central banks track the movement. It makes sense that the debt market here also track the US debt market.”
Bond market dealers say the trend could be here to stay.
“One can say so ... our bond markets are becoming more or less globally aligned. If the FII limit is increased in the debt market, as some reports suggest, it could end up becoming a permanent feature,” said said G.A. Tadas, managing director of IDBI Gilts Ltd.
“FII flows will directly impact the local debt market here and US debt market will become one more crucial factor for us to monitor closely,” Tadas said.