At the beginning of fiscal year 2018, the sentiment among investors in Indian bonds was upbeat thanks to slower retail inflation and a dovish Reserve Bank of India (RBI).
The Indian debt market saw steady inflows from foreign portfolio investors, essentially aided by the dovish stance of global central banks (see chart). Now, however, inflows have petered out suggesting that the mood may be changing due to a combination of domestic and global factors.
Inflation as measured by the Consumer Price Index is expected to move higher, thus limiting scope for an interest rate cut. So far in this fiscal year, RBI has trimmed its policy rate once by 25 basis points in August. The central bank is expected to maintain status quo on rates in October.
Secondly, there are fears of the fiscal deficit widening following reports that the government is considering a stimulus to boost sluggish economic growth.
“Considering the current fiscal run-rate and a strong possibility of revenue losses owing to lower-than-expected RBI dividend, GST (goods and services tax)-led possible tax shortfall and disinvestment proceeds shortfall, the fiscal slippages may occur and could amount to ~0.3-0.7% of GDP (gross domestic product). The consequent borrowing pressure would worsen the bond market dynamics,” Kotak Institutional Equities said in a report.
Also, yield-hungry foreign investors would be closely following developments related to the US Federal Reserve’s unwinding of its balance sheet and decisions by other global central banks.
According to some bond market analysts, a higher downside risk to Indian bond yields emerges from the movement in global bond yields and currencies rather than transitory domestic factors. They foresee the benchmark 10-year yield hovering in the 6.4-6.8% range in the near term.
“We expect the 10-year bond yield to remain around the 6.5% mark for the next three-six months. Interestingly, bond yields currently are at around the same level where they were in May this year, so the year has seen some volatility, but not much direction. We don’t expect 10-year bond yields to harden unless there is a negative surprise on the fiscal front,” said R. Sivakumar, head (fixed income) at Axis Mutual Fund.