Heightened uncertainty puts bond markets in unchartered territory: Chopra

From a one-year perspective, if there are no rate hikes and the 10-year g-sec yields stay at 7.25-7.50 per cent, investors can get 8-8.25 per cent for the year in short-duration funds

A sharp reversal in expectation has led to high volatility in the domestic bond markets, says AMANDEEP CHOPRA, group president and head-fixed income, UTI Mutual Fund. In an interview to Vishal Chhabria, he says if there are no mitigating factors in the Union Budget and the Reserve Bank of India’s (RBI’s) policy review, the 10-year government security (g-sec) yields could rise to 7.75 per cent. Edited excerpts:

The bond market has seen a lot of action recently, as the government’s fiscal math hasn’t played well. Even after the government cut its additional borrowing figure to Rs 200 billion, from Rs 500 billion, some believe the actual numbers could be much worse. Your take?
 
Bond markets are seeing a fair amount of volatility, led largely by a reversal in expectation, driving both rates and volatility.
 
What I mean is till about September, the inflation and crude oil outlook was largely benign. There was an assumption of better tax mobilisation after the goods and services tax (GST) and no fiscal slippage. So, stable policy bias was expected from the RBI. Quite abruptly, these expectations began collapsing as data flow became negative, forcing the markets to recalibrate their expectation. The revised calendar with additional borrowing of Rs 500 billion was the tipping point for sentiment to become completely negative.
 
Heightened uncertainty, with fractured market sentiment, puts the bond markets in uncharted territory.
 
Against this backdrop, the reduction in additional borrowing is only marginally positive and isn’t helping improve the sentiment when the other drivers remain unsupportive. A 20-30 basis point (bps) shift in the fiscal deficit target doesn’t seem a big number but adding Rs 300-500 billion of excess (paper) supply when sentiment is already not conducive exaggerates the market moves. The bond markets will remain somewhat sceptical on the deficit numbers for FY19 as well, since India heads into elections.
 
So, where do you see bond yields ending by March and by December?
 
That’s a tough call, as there are too many moving parts. The yields by March and December will be more a result of certain outcomes. If there are no mitigating factors in the Union Budget and the RBI policy thereafter, the band for the 10-year g-sec is clearly heading upwards. I will not be surprised if yields rise to 7.5–7.75 per cent. We were looking at a band between seven and 7.4 per cent earlier but it’s already tested that. And, this is still in a backdrop where crude oil is hovering around $69.
 
The only way I see it coming down is if the Budget does not indicate a slippage of more than 10-20 bps in fiscal deficit. Second, if the RBI does not change its stance and remains neutral. Third, if crude oil stays below $70 a barrel. Finally, how global central banks react. They are already either shrinking their balance sheet or initiating a rate hike, if not already done.
 
Apart from pressure on the Union government’s fiscal, state governments are also taking of farm loan waivers. Their budgets are also in a mess.
 
It is a big worry. The populism that markets are worried about today is something you’ve seen in the past. You have some very important state elections coming in. A lot is at stake. So, if they start taking some of these populist measures, the bond markets will really take it badly.
 
What would be the impact on bond yields, if say crude oil ends at levels higher than expectations?
 
For FY19, the average crude oil price estimate is around $65. A $10 average rise, increases the CPI (consumer price index) by 60-70 bps and the CAD (current account deficit) by 35 bps of gross domestic product. With higher inflationary expectation and its impact on the rupee, it will lead to bond yields moving up. The worry in all this is if the RBI becomes hawkish and hints at rate hike.
 
What returns could investors expect in 2018?
 
Given the many concerns, a long duration strategy might not outperform. So, the focus will remain on being low on duration, such as short-term income fund, income opportunity fund and ultra-short-term fund, unless these risks start plateauing. If the negative trends in crude oil, inflation, etc, start peaking, it might offer some trading opportunities. In such a cycle, it is a good time for investors to start systematic investment plans in income funds.
 
From a pure one-year perspective, if there are no rate hikes and the 10-year g-sec yields stay at 7.25-7.5 per cent, investors can get between eight and 8.25 per cent for the year in short-duration funds without taking on risk. If they take on a bit of risk, maybe slightly higher, they will outperform bank fixed deposits and beat inflation.