Cause for concern: Biggest bond yield spike in Budget week since 2017

Since the finance minister's speech, yield on 10-yr paper has jumped 20 bps

This week turned out to be the worst budget week for the bond market in five years, with the yield on 10-year government securities moving up 20 basis points since Finance minister Nirmala Sitharaman’s speech on February 1. 

The yield on the 10-year government paper closed at 6.88 per cent on Friday, after hitting an intraday high of 6.95 per cent -- the highest level in two-and-a-half years. The yield cooled off by the end of the trading session after the weekly bond auction, in which the central bank rejected bids but did not devolve on primary dealers, the underwriters of the bonds.

The yield on the 10-year paper closed 5 basis points lower than its previous close (100 basis points = 1 percentage point).

Bonds yields surged after the Budget announced a massive borrowing programme for the next fiscal year. The net borrowing will be Rs 11.19 trillion in 2022-23 against Rs 7.76 trillion in the current financial year.

The RBI on Friday sold Rs 2,000 crore worth of papers maturing in 2023, while it raised Rs 8,525 crore selling bonds maturing in 2051 (against Rs 7,000 crore planned against the maturity).

But the central bank declined to sell any of its bonds maturing in 2026, against which Rs 6,000 crore was planned, and the bond maturing in 2035 against which Rs 9,000 crore was planned.

According to experts, this is a signal by the RBI to the market that yields have moved too fast, and that the central bank is keen on keeping them contained within a certain level.

But market participants expect bonds to remain under pressure.

“Expectations for any improvement in the supply-demand mismatch for IGBs in FY23 were quashed by the recently proposed Budget,” Bank of America said in a report.

“A higher-than-expected deficit target led to much higher net borrowing requirements. More room has been provided to states by raising the limit of states borrowing to 4 per cent of GSDP, from 3 per cent currently. With the RBI turning into a seller of bonds over the last three months, from a large buyer in H1FY22, a gap has been left that was earlier expected to be filled by foreign demand from indexed flows. However, an impasse over taxation has kept that hope dangling by a string,” the report said.

Puneet Pal, head-fixed income, PGIM India Mutual Fund, said: “We think that over 6- 8 months, yields are headed higher in the vicinity of 7.25 per cent to 7.35 per cent. In the near term, yields are not likely to breach the 7 per cent-mark as they have already risen by 50 to 60 basis points(bps) in the past couple of months and at these levels, yields are discounting a lot of negatives. The RBI has been calibrated in its conduct of monetary policy and as such we do not expect aggressive rate hikes by it. We are expecting a 100-basis point increase in the policy repo rate by April 2023.”

Next week the central bank is scheduled to announce the last bi-monthly monetary policy review of the current financial year. A section of market participants expects the RBI to hike the reverse repo rate in a signal to normalise the ultra-loose monetary policy stance that has been in force since the advent of the Covid-19 pandemic in March 2020. Normalising the rate corridor -- the gap between repo and reverse repo -- to 25 basis points as compared to 65 basis points now could be the first step towards unwinding the accommodative stance.