The bond market has shrugged off the 2G spectrum auction flop. The auction managed to garner Rs.9,400 crore, less than one-fourth of what the government had budgeted for, and economists are scrambling to revise fiscal deficit estimates upwards.
But 10-year government bond yields have scarcely moved, hovering around 8.21% over the past week or so. Dealers say that the market had known anyway that the deficit figures presented in the budget were pie in the sky so confirmation of that didn’t evoke much of a reaction.
Sure, intra-day data showed yields had inched up to 8.22%, a two-month high, but these gains were given up on hopes of the central bank resuming its open market bond purchases.
Banks are borrowing over Rs.1 trillion daily under the Reserve Bank of India’s (RBI’s) overnight window—a sign of liquidity stress in the system. With the cash reserve ratio already near record-low levels, the obvious way to alleviate this pressure is through open market operations. Till June, RBI sold bonds worth Rs.54,600 crore. Dealers expect full-year bond purchases by the central bank to touch Rs.90,000 crore.
Secondly, economic data released last week have made the case for a cut in the benchmark interest rate. The wholesale price inflation data for October was reported at 7.45%—not only a six-month low, but also below Street expectations. Core inflation, a truer indication of demand pressures in the economy, is down. Then again, September factory output data showed a contraction of 0.2% pointing to growth pressures. To be sure, RBI in its last monetary policy statement had indicated that any rate cut measure wouldn’t happen before the January-March quarter, but recent data has raised hopes, keeping yields under check.
Perversely, an increasing current account deficit is also doing its bit as it forces the government to seek new ways to boost capital inflows. A Reuters report on Tuesday said the government is considering raising the ceiling on foreign investments in government and corporate bonds by $5 billion each.
The yield differential on 10-year Indian government bonds and US treasuries of the same maturity is around 6.5 percentage points. Thus, an increase in the investment limits could boost foreign demand for this paper, especially since the threat of a sovereign downgrade seems to have been averted for now.
All this suggests that bond prices have bottomed out, for now. However, if a rate cut doesn’t materialize in January, things could change.