DEBT OUTLOOK By Pankaj Pathak Fund Manager – Fixed Income Quantum Liquid Fund & Quantum Dynamic Bond Fund
Indian Bond yields continued its bearish run much to the dismay of the government and the RBI. The 10 year bond yield see-sawed 7.4% at the start of the month to 7.12% in the first week of April but ended the month at 7.75%. Bond market volatility remains at painfully high levels.
We use the word ‘dismay’, because between the Finance Ministry and the RBI have tried to manage sentiment and get the bond yields lower.
The Finance Ministry announced lower than normal first half borrowings to improve the bond market sentiment and aid bond valuation at the end of the March quarter. The RBI then did its bit, first by allowing banks to postpone recognition of its bond portfolio losses of December 17 and March 18 quarters by spreading it evenly over the next 4 quarters. It then gave, what seemed like a ‘dovish’ commentary on the inflation outlook triggering a sharp rally in the first week of April with bond yields rallying and bottoming at 7.12%.
With bond yields rising again, the RBI then announced an increase in investment limits for foreigners in government and corporate bonds. The limit increase though was disappointing as it was lower than expected and yields continued to climb. The release of the ‘minutes’ of the April monetary policy was seen to be completely at odds of what was mentioned in the policy with the markets interpreting the RBI to be ready to hike interest rates. Bond yields climbed to 7.8%.
At the end of the month, the RBI eased investment rules for foreigners in Indian debt by allowing them to buy government bonds of any maturity as against the existing rule of above 3 years maturity. This we believe is a regressive move and would encourage more short term leveraged flows into the bond market. In 2014, RBI under Raghuram Rajan, had called such investment flows as ‘bond tourists’ and disallowed investments in less than 3 year maturity bonds. The move now to allow investments across maturity profiles is an attempt by the RBI to stem foreign investor outflows at a time when the INR has also been under pressure and is depreciating. Maybe the RBI expects that capital flows won’t be enough to fund the current account deficit and thus is encouraging inflow from bond investors to support the rupee as well as to get bond yields lower.
With inflation at 4.5%; Repo rate at 6.0%; a 3 year government bond is trading at 7.5% and a 3 year AAA PSU issuer has to borrow ay 8.25%, these are clearly stretched valuations and tight financial conditions and threatens to derail the ongoing slow economic recovery.
The RBI will have to act in some manner to correct the yield curve and get yields to down. All their efforts so far have not come to fruition as the INR continues to depreciate due to on rising oil prices, pressure to book profits by PSU banks and net selling by foreigners. These factors have led to a continued rise in bond yields.
Going ahead, market will closely watch the extent of Minimum Support Price (MSP) increases for the Kharif crops which will be available by May 2018. By that time, we would also get a clearer assessment of monsoons, which given the low water reservoir levels, assumes significance for food production and prices. The RBI policy for June 2018 thus holds major significance with implications on future rate trajectory.
Although we had anticipated the rise in bond yields back in August 2017 but the extent of surge in yields had been much higher than our anticipation. For bond markets, with the yields back up, valuations are getting attractive especially in the short tenor segment from 1- 5 years.
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