Mumbai: Yields on government bonds fell sharply on Tuesday to a level last seen after the shock ban on high-value currency notes in November 2016, buoyed by the prospect that the central bank will effect deeper rate cuts to bolster growth amid low inflation.
The yield on the benchmark 10-year bond declined 10 basis points to 6.33% on Tuesday, a level last seen on 6 December 2016. Year to date, the bond yield has fallen nearly 100 basis points. Bond yields and prices move in opposite directions.
India’s core inflation eased to 4.1%, its slowest in nearly two years, down from 4.23% in May, according to government data on Friday. Retail inflation for June was at 3.18%, holding below Reserve Bank of India’s (RBI) 4% target for the 11th straight month. This, juxtaposed with India’s May factory output weakening to 3.1% from 3.4% in April, has kindled hopes of continued monetary easing and further rate cuts. The next meeting of RBI’s monetary policy committee will be held from 6-7 August.
The other reason is the government’s plan to raise part of its borrowing from overseas markets. The move is expected to reduce supply of bonds in the domestic market, which will also have an impact on prices.
In addition, the government’s lower fiscal deficit target—3.3% from 3.4% envisaged in the interim budget—has boosted investor sentiment.
Economists expect offshore borrowing to reduce pressure on domestic interest rates.
Falling bond yields globally, amid expectations of the US Federal Reserve adopting a dovish stance, also influenced domestic yields.
The next US Fed meeting will be on 31 July.
“Domestic catalysts for bonds are largely positive in the short term, with yesterday’s downbeat trade numbers reaffirming a slowdown in domestic demand, making a case for further monetary accommodation,” Radhika Rao, an economist at DBS Bank, said in an email from Singapore. “Separately, June retail and wholesale inflation remained below target, while core CPI inflation continues to retreat mirroring subdued on demand pull pressures. Oil prices continue to seesaw on geopolitical rumblings, with a break above $70 per barrel needed to shake confidence in the currency and yields. These cement our expectations of a follow-up 25 basis points cut in August, a fourth this year.”
According to Bank of America Merrill Lynch, RBI may cut rates by an additional 75 basis points in 2019 if rain the rain deficit narrows. Monsoon rain has been 13% below normal so far this season, according to a Bloomberg report.
With this expectation of deeper rate cuts, Deutsche Bank AG expects the 10-year bond yield to decline to 6% by the end of 2019, and further to 5.75% by the end of March. The median forecast in a Bloomberg survey is at 7.10% by the year-end and 7.18% by March 2020.
On 16 July, Business Standard newspaper reported that India’s first issue of overseas sovereign bonds may be around $3-4 billion with a maturity of 20 years.
“Beyond August, we are holding out for another rate cut. If inflation continues to stay below 4%, helped also by a favourable spatial spread and narrower shortfall in the rainfall, more easing is in the pipeline,” Rao said. “Two announcements are due this month—RBI capital framework panel will shed light on a quantum of RBI dividends (key for revenues), followed by the liquidity framework report (as announced in the July policy review); indications of a high dividend contribution coupled with signs that liquidity conditions will be kept favourable, could trigger further gains in bonds.”