Mumbai: The yield on the 10-year benchmark government bond that touched 4.86% in January is set to close the year at around 7.70%. Similarly, the value of the domestic currency, which had dropped to a record low of 52 a dollar in March, gained at least 11% to settle at around 46.70 at end-December.
The huge volatility in bond and currency markets in 2009 was a direct fallout of the global financial crisis of 2008. Bond and currency dealers say it will spill over in 2010 as well, at least in the first half, though the intensity of the movement is likely to be less.
After the collapse of US investment bank Lehman Brothers Holdings Inc. in September 2008, in sync with global central banks, the Reserve Bank of India, or RBI, pared its policy rates drastically and induced huge liquidity into the system to fight the credit crisis.
The government also announced stimulus packages worth at least Rs3 trillion, leading to a fiscal deficit of 6.8% of the country’s gross domestic product, or GDP. This is being bridged through a market borrowing of Rs4.51 trillion.
Key to the movement of the bond yield will be the government’s ability to bring down the fiscal deficit. Dealers expect the government’s borrowing programme to be marginally lower in next the fiscal year “but how much lower is the question”, said Joydeep Sen, senior vice-president, advisory, BNP Paribas Wealth Management.
Crucial factor: Developments in the US will have a bearing on the rupee’s movement in 2010. Amit Bhargava / Bloomberg
Even if the borrowing programme becomes lower, bond yields are unlikely to come down from the present level as RBI may tighten its monetary policy by hiking interest rates and increasing the cash reserve of banks, or the portion of deposits banks need to keep with RBI to rein in a rising inflation.
A hike in the interest rate would increase the yield, but only marginally over present level, dealers say.
“If there is a hike in cash reserve only, then 10-year bond yields could go up to 7.75-7.80%, but if there is hike in both rates and cash reserve, the yield could go to 7.90-7.95%,” said G.A. Tadas, managing director of IDBI Gilts Ltd, a primary dealer that buys and sells government bonds.
Bond dealers say the current yields have taken into consideration almost all negative factors, including possible rate hikes by the central bank.
“I would say the bond yields have factored in more than the negatives. Even if there is a rate hike in January, the bond yields won’t move much,” said Jayesh Mehta, managing director and country treasurer of Bank of America NA.
“The year 2009 was a volatile year. Dealers were happy with smaller gain and the trick was not to lose money. Hopefully, 2010 will be much better, volatility will be not that high,” he added.
According to Tadas, the volatility observed in the last few months of 2009 was also because of increased preference for “shorting” the bonds. In India, traders can short government bonds for a maximum of five days.
Shorting is the practice of selling a bond that a dealer does not own. One can keep the position open for up to five days and there is a limit to the extent one can short a bond.
The shorting in the last few months was more frequent and faster than seen in the past few years, said Tadas. “It induced a lot of volatility.”
“The bond market started the year on a bullish note but the government borrowing spooked the market,” said Sen of BNP Paribas. The government’s borrowing programme was much more than the market could absorb.
In fact, the bond market rallied across the globe as investors withdrew their money from risky equity classes and invested in government bonds. “Worldwide, the fundamentals were conducive for the bond market. But in India, the market did not move in tandem with the fundamentals,” said Mehta of Bank of America. This was because of the government’s huge borrowing programme.
Rupee may strengthen
In contrast to the bond market, where domestic factors play a large role in influencing the price movement, the rupee-dollar market is more linked to the external factors.
India could be relatively better off than many other countries in 2010 as far as the strength of the local currency is concerned, foreign currency dealers said.
Global investors are expected to invest in emerging markets, including India, and capital flows are expected to pick up. In 2009, foreign investors have bought $17.3 billion worth of Indian equities, close to their buying level in 2007 when the local currency strengthened to 38 a dollar level. In 2010, this flow is expected to increase.
“The confidence level is returning. People have started taking risk and this should bode well for the Indian rupee,” said Satyajit Kanjilal, chief executive officer of foreign exchange consulting firm Forexserve.
“It’s not that the Indian rupee will not get affected by the global currency movements. But the impact will not be that severe as in 2009,” he said.
According to Kanjilal, the rupee could trade between 46-49 a dollar with a bias towards strengthening in 2010.
Apart from the inflow of foreign funds, developments in the US will have a bearing on the rupee’s movement in 2010.
“We will get a clear picture of the rupee-dollar rate by the end of (the) second quarter or starting of the third quarter. By that time, we will get to know more about the US recovery and how the dollar behaves against the major currencies,” said Pramit Brahmbhatt, CEO of Alpari Forex (India) Pvt. Ltd, the local arm of the UK-based foreign exchange trading firm.
“The volatility of 2009 will continue till the first half of 2010 and the rupee should trade between the broad range of 44-48 a dollar,” Brahmbhatt said.
Bond and foreign exchange dealers say the three most important factors to look out for in 2010 would be recovery, both in the global and domestic scene, inflation, and how the government manages its finances in its 2010-11 Budget.