Despite the recent correction in Indian bond yields, domestic catalysts suggest a largely positive outlook for the bond market in the short-term, a report said Tuesday.
Global drivers are also supportive as US yields harbour expectations of a dovish US Fed and a likely rate cut at the meeting later this month.
India’s 10-year (generic) bond yields have corrected sharply from 6.75 per cent ahead of the budget to 6.45 per cent on Monday, according to Singapore’s DBS Group Research Report.
Correction in the rate sensitive 2Y yields was relatively smaller, from 6.23 per cent to 6.17 per cent, having already baked in monetary easing expectations, wrote the bank’s Economist Radhika Rao and Rate Strategist Eugene Leow in a report Tuesday.
“This has led to flattening in the yield curve versus a month ago, with 6.4 per cent offering support for the 10Y, while 2Y yields stay above 6 per cent. A strong dovish signal will be the next trigger for a break below,” the duo said in the report.
Domestic catalysts for bonds are largely positive in the short-term, barring Monday’s downbeat trade numbers, they said.
June exports declined 9.7 per cent year-on-year accompanied by a similar decline in imports, keeping the trade deficit wide at above USD 15 billion, the report noted.
Separately, June retail and wholesale inflation remained below target, whilst core consumer price index (CPI) inflation continues to retreat, mirroring subdued demand pull pressures.
Oil prices continue to seesaw on geopolitical rumblings, with a break above USD 70 per barrel needed to shake confidence in the currency and yields.
“These cement our expectations of a follow-up 25 bp cut in August, a fourth this year,” said Rao and Leow.
“Beyond August, we are holding out for another rate cut, likely in 4Q19.”
If inflation continues to stay below 4 per cent, helped also by a favourable spatial spread and narrower shortfall in the rainfall, more easing is in the pipeline, the duo believes.
Two announcements are due this month – RBI capital framework panel to shed light on a quantum of RBI dividends (key for revenues), followed by the liquidity framework report (as announced in the July policy review).
Prospect of a sovereign bond issue announced in July’s Budget has divided market participants, with few ex-RBI governors speaking against such an issuance, they pointed out.
While the government’s intention is to tap a new investor base and lighten domestic issuance, concerns arise like exchange rate risk borne by the government, small net savings on cost on hedged basis and another avenue for external volatility to permeate through to the domestic markets.
There are also risks of cannibalising portfolio debt inflows and increase in external debt (foreign reserves are 70 per cent of total external debt).
These are pertinent risks, which might require the authorities to take the ‘good with the bad’ if issuance plans stay on track, said the duo in a report.
Given the skewed nature of debt to equity foreign portfolio investors (FPI) inflows to India (Rs 7 equity for every Rs 1 debt), door can be opened to more dollar debt, they believe.
Better forex reserves stock is another positive, provided total quantum of issuance is kept at manageable levels.
“Speculation for a USD 10 billion issuance has surfaced, likely in 2H FY20 (Oct-Mar); the final quantum is likely to be smaller in our view, given the time remaining and a maiden foray into sovereign offshore debt,” said Rao and Leow.