Widest India bond-swap spread in seven years lures Goldman Sachs

The gap between the five-year bond yield over similar-tenor overnight index swap is 126 basis points, data compiled by Bloomberg show. The last time the difference was this wide, in January 2012, yields retraced for two weeks.

The spread may narrow to 70 basis points, with rates markets already pricing in easing to exceed 25 basis points seen by the bank by year-end, analysts including Danny Suwanapruti wrote in a note.

Bond markets in India have been weighed down recently by worries over fiscal slippage and the uncertainty over shifting a part of the government’s record borrowing overseas. Benchmark yields have climbed 21 basis points in August, while the long-end swaps are down 40 basis points amid softening in global yields.

Finance Minister Nirmala Sitharaman announced a spate of steps last week to lift growth from a five-year low, but didn’t offer any major fiscal measures. The central bank late Monday agreed to transfer a record $24 billion surplus to government coffers, a move that is expected to help Sitharaman stick to the fiscal deficit target.

Growth is likely to rebound in the second half, with inflation edging up toward the midpoint of the central bank’s target, according to Goldman.

“The administration’s focus on achieving its fiscal target, supported by an additional RBI capital surplus transfer and a potential improvement in bond demand from banks, should help balance the bond supply-demand outlook," the analysts wrote. Goldman’s stop-loss for the trade is 155 basis points.

The swap market is driven largely by overseas investors, whose themes are typically influenced by the outlook on global rates, said Naveen Singh, head of fixed-income trading at ICICI Securities Primary Dealership in Mumbai. The local bond market, on the other hand, is dominated by state-run banks and insurance companies, who have shown low appetite for bonds, he said.