Mumbai: The government bond market seems to be in a firm bear grip. The yield on the benchmark 10-year paper has already crossed 8% and bond dealers expect it to reach 8.25-8.40% in next two-three months as they say there is a little incentive left to trade in the market.
Earlier on Thursday, dealers were expecting either a 50 basis point hike in the cash reserve ratio (CRR) that commercial banks keep with the Reserve Bank of India (RBI), or in interest rate, or even both, when the central bank announces its monetary policy on 29 April. But RBI surprised the banking community by announcing a 50 basis points hike in CRR on Thursday itself. Hundred basis points make one percentage point.
Oversupply: RBI has auctioned Rs11,500 crore worth of bonds after last week’s Rs23,000 crore bond and T-bill sales, including MSS bonds. (Photo: Harikrishan Katragadda/ Mint)
Rising inflation rate, currently ruling at a three-year high of 7.41%, much higher than RBI’s comfort zone of 5%, and huge supply of bonds under the government’s borrowing programme as well as the market stabilization scheme (MSS), are the two main factors that have been pushing up the bond yields. The government borrows from the market every year to bridge its fiscal deficit. Parliament allowed creating the MSS bonds to soak up excess liquidity from the financial system.
Fearing an impending rate hike, which will further push up the bond yields, traders are not taking large positions in the market. US lender JPMorgan Chase and Co. has said in a recent research note that the 10-year bond yield will reach 8.4% by June. The bank cited “outsized issuance, limited investor demand and an unfriendly monetary policy backdrop” as the reasons for the bond yield to head north.
RBI has auctioned Rs11,500 crore worth of bonds after selling Rs23,000 crore of bonds and treasury bills, including the MSS bonds, last week.
For fiscal year 2009, the government plans to borrow Rs1.45 trillion from the market. It has also increased the ceiling of MSS bonds to Rs2.5 trillion. Out of the regular borrowing programme, Rs96,000 crore, or 66%, is scheduled to be issued in the first half of the fiscal year.
In the last week of January, when bond dealers were expecting a rate cut, the yield on the 10-year paper dipped to 7.34%, and many financial firms, including public sector banks that were sitting tight on their bond holdings for a year, took advantage of the dipping bond yields to book profits. Bonds prices and their yields move in opposite directions.
The scenario changed in March, when liquidity tightened due to the advance tax outflow, and inflation started rising. “There is no sign of inflation rate easing. In fact, the market is expecting that the inflation will touch 8% in the next couple of weeks,” said J. Moses Harding, executive vice-president and head (wholesale banking group) at private sector lender IndusInd Bank Ltd.
Joydeep Sen, vice-president of advisory desk for fixed income at banking group BNP Paribas, blames the government’s Rs60,000 crore farm debt waiver and its Sixth Pay Commission recommendations to raise government salaries for the rising yields.
According to Harding, the market had already factored in a 50 basis point hike in CRR, and if that happens, the bond yield would not move much and may remain range-bound at 7.95-8.05%. If some further monetary measures are taken, the yield might move to 8.15-8.25%, he said.
Sen of BNP Paribas is, however, bullish on the bond market in the long run. “Over the long term, I am bullish on the bond market. Globally, interest rates are softening, our growth rates are tapering down and the inflation rate should come down going forward, which would boost the market sentiments.”
JPMorgan’s forecast of 8.40% yield by June does not take into account a possible rate hike. “Our base case scenario is not for interest hike. If interest rate hike happens, we probably would be looking at a greater upside,” said an analyst with the bank, who did not wish to be named.
Interestingly, the continued growth of the economy is also playing spoilsport. “People were expecting the economy to slow down, but it really didn’t. The industrial figures released last week were more than what the market expected. It seems the bond market is not liking the continued growth of the country,” said the treasury head of a public sector bank, who also did not wish to be identified.
When the economy slows down, investors rush to bonds for a safe haven. India’s index of industrial production rose 8.6% in February, up from 5.8% in January.