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Mumbai: The bond market rally which began the Monday after Raghuram Rajan announced his decision to step down as Reserve Bank of India (RBI) governor has taken on a life of its own.

On Thursday, the 10-year benchmark bond yield fell 6 basis points to 7.19%, coming within striking distance of levels seen back in 2009. Yields are already at their lowest in more than three years and a drop of a few more basis points could take us back to the days of September 2009 when the 10-year yield was at 7.15%.

Such is the optimism in the market that even a fall to levels below 7% is not being ruled out. The last time India had a sub-7% benchmark yield was in July 2009. That was a time when the repo rate was 4.75%—175 basis points below the 6.5% policy rate today.

“...we continue to expect a further rally in rates with 10-year G-sec yield likely to drift lower towards 7% before the end of FY17 on the back of another 25 basis point repo rate cut by the RBI in Q3 FY17 and around 1 trillion in incremental OMO (open market operation) purchases," said Yes Bank in a research note on Thursday.

The factors that are driving the rally are a combination of global and local. Glocal, as many analysts call it.

The first burst came, ironically, after Rajan’s 18 June decision not to seek an extension, in the hope that the new central bank governor will be more dovish. Domestic liquidity also turned neutral around the same time and there were strong inflows into debt funds—all factors that contributed to strong demand for government securities in the market.

Then came the Brexit vote which pushed investors towards government bonds across all markets. What has been interesting and perplexing in the post-Brexit market scenario is the fact that the move towards government bonds has not signified the typical mood of risk aversion. Instead, investors have continued to chase emerging market assets, including emerging market bonds.

This has meant a further contraction in emerging market bond yields and India has been no exception.

Since the Brexit vote, India yields have fallen 28 basis points. This is actually lower than the 34 basis point drop in yield seen across peer group countries, according to the Yes Bank report.

Foreign investors bought about a billion dollars in Indian debt in July—the highest since October 2015.

“The unprecedented conditions in the developed world bond markets are leading to an acceleration of flows into emerging market debt. This makes complete sense since a premium should be paid for those government bond markets where monetary policy is still orthodox. This, in turn, will create a following wind for emerging market equities in the form of declining bond yields and strengthening currencies," wrote Christopher Wood, managing director and equity strategist at CLSA on 21 July.

The big beneficiaries of this fall in borrowing costs (apart from the government) have been firms that can shift their borrowings from banks to markets.

In the commercial paper markets, top-rated companies are borrowing for three months at 7.25%, the lowest since August 2010. In the overseas markets, too, borrowing rates are down sharply. Earlier this week, pharmaceutical firm Glenmark issued five-year bonds for an eye-popping 4.5%. This was apparently the lowest yield a sub-investment grade India firm has ever borrowed at.

When things are looking this good, they rarely last. So what could end the party?

Domestically, the appointment of an RBI governor who is not as dovish as the market hopes he will be could dent the mood. Globally, if investors eventually buy the sombre message being put out by the bond markets, the lure of emerging market assets, including bonds, could weaken.

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