Election years are not easy for the bond market as they tend to render more volatility than in non-election years. But 2019 could prove different if the Reserve Bank of India (RBI) lends a hand. From the RBI’s statement on Tuesday, it looks like the central bank will take big chunks of bonds from the market onto its balance sheet. RBI would have bought ₹ 2.6 trillion worth of government bonds by January if it sticks to its commitments.
The benchmark 10-year bond yield has dropped 20 basis points this week to hit 7.26% on Thursday and is expected to fall another 10-20 basis points going into 2019. As Soumyajit Niyogi, associate director, India Ratings puts it, “OMO (open market operation) turns out to be the biggest swing factor for the bond market, and with further reinforcement of more OMO from the newly appointed governor, the market expects more to come."
Besides, the bond market has a host of other factors going for it next year.
First, the retail inflation trajectory has taken a positive downside turn and has come below the Reserve Bank of India’s (RBI) projections. The central bank has cut its inflation forecast thrice this year due to falling food prices. Analysts expect headline consumer price index (CPI) inflation to average not more than 4.70%. Of course, the assumption of normal monsoon and stable oil prices underpins this forecast. Kotak Securities expects the CPI inflation to average 4.3% in fiscal year 2019-20 and core inflation to average 3.4%. Hence, the outlook on inflation should motivate bond purchases and depress yields.
Secondly, global crude oil prices were the single factor that upset many forecasts on inflation, exchange rate and even policy rates this year. Forecasts for oil turned from being relatively accurate to stabs in the dark. After all, oil’s rise of 22% and precipitous fall of 33% in just four months is enough to rattle the most steadfast of forecasters. Bond traders took note of this as yields mirrored the movement in crude oil prices to a great extent.
But the New Year is expected to be less eventful. Forecasts for oil range from $60-$70 per barrel. “Our 2018 annual average estimate has been raised slightly to $72.5 per barrel to reflect year-to-date outturns but our 2019 assumption is unchanged at $65," said Fitch Ratings in a note.
With oil behaving, the biggest pressure of imported inflation on domestic inflation is contained. Ergo, bond yields would price in a policy rate cut and a softer monetary policy stance.
Finally, it bears repeating that liquidity will drive the bond market next year and a large part of the fuel is likely to be provided by the RBI. While the feared fiscal profligacy associated with an election year may manifest, the RBI is ready to take the load off investors. Bank of America Merrill Lynch expects the RBI to buy a total of ₹ 1.5 trillion worth of bonds during the January-March quarter.
That said, short-term volatility from elections cannot be overlooked. Nomura Securities sums up the bond market mood for 2019 here, “The RBI’s proactive liquidity management approach, along with downward inflation surprises means we remain constructive on India bonds, especially heading into 2019, but we are concerned that India rates will start to command some political risk premium ahead of elections in Q2 2019."