Yields Stable to Lower but Pressures Persist

Yields have been stable to lower but maintaining a range which is 7.15 % to 7.35 % on the ten-year benchmark. One of the encouraging factors is the inflows into bonds from the overseas investors in the last one month which has instilled some confidence in the market participants. A second factor that has brought some amount of positivity is the speculations around the inclusion of gilts in overseas bond indexes. In case of an inclusion there could be passive investments into local bonds from overseas investors. Many large investors across the world follow one or the other bond index while making investments. The expectation is that this inclusion could bring in greater demand for bonds. Out of what is currently available for overseas investors, the FPI debt utilization status is only 27 % for Gilts and for SDLs it is just 1 %. Therefore, any major inflows would require us to take the convertibility of the Rupee to a higher level, the requisite tie ups with international clearing agencies, and also clarifications on the tax laws. While inclusion in the indexes may bring in more money over a period of time the volatility may be much higher compared to the current situation. Also, macro fundamentals will become more relevant in determining the direction of the markets.

The yields would still be under pressure for a number of reasons. There are three facts which may lend some credibility to this proposition. The first one is that inflation is likely to move lower from the current 6.70 %, but the RBI’s target is 4 % in the next two years. That is close to the median of the target range for the central bank. The stickiness of inflation is not entirely due to food and fuel. Food prices may move up and down with climate and rainfall, and the supply from rural centres. But the other components too have the momentum in prices. It may be sometime before there is reasonable moderation in the price level. Given the current price level pressures which may persist longer, the RBI is likely to hike rates further. RBI has reiterated the policy stance and has stated its commitment to bring inflation lower. The budgeted borrowings have been completed to the extent of 47 %, and the borrowing programme has been so far non-disruptive. With almost 50 % plus of the borrowing being completed by end of September, it may be a less arduous task when it comes to the second half of the year though we may need to watch out for any additional borrowings coming up.

The cut off in the SDL auctions for 10 year was at 7.61-7.62 %, 12-year at 7.67 %, 15-year at 7.71 %, and 20-year at 7.70-7.72 %. The spread of the 10-year SDL against the 10Y G-sec benchmark is at 40 basis points. The ten- year GOI benchmark security is trading around the 7.20 % -7.30 % since last couple of weeks. But it has not been able to break the barrier at 7.30-7.35 % so far. But given the factors enumerated above an attempt to pierce through this resistance level and targeting 7.50 % -7.60% level cannot be ruled out. Much would depend upon how the RBI is able to manage the primary issues without too much of disruption. That would require liquidity support in view of the dwindling systemic liquidity. But whether RBI would be willing to undertake this delicate operation at a time when the currency is relatively cheaper, and the rest of the world is on an aggressive tightening mission to control inflation. Investmenst directly into bonds with three-years maturities, or into SDL funds which would bring benefits of indexation may be looked at for long term portfolios.


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