Worst rout of sovereign bonds in 7 years may end with RBI's Rs 860 bn binge

With India’s central bank emerging as the biggest buyer of government debt, some traders are calling time on a rout that’s lasted more than a year and sent benchmark yields soaring to a four-year high.

The Reserve Bank of India bought 860 billion rupees ($11.8 billion) of bonds between May and October, and plans to inject 400 billion rupees this month to replenish liquidity drained by its currency defense and a seasonal cash crunch. The purchases will help shrink the supply of paper for the fiscal second-half by 80 percent from a year earlier, according to estimates by Nomura Holdings Inc.

“It’s unlikely that sovereign yield could flare up again,” said Sandeep Bagla, associate director at Trust Capital Services Pvt. in Mumbai. “The RBI is emerging as the largest buyer of government bonds as it attempts to combat a rapidly tightening liquidity scenario.”

The purchases have coincided with a rapid cooling in oil prices that helped drive the yearlong selloff in bonds, the worst run of quarterly losses since 2011. The cash crunch in the banking system may prompt the RBI to extend its support beyond November, according to ICICI Securities Primary Dealership Ltd.

“In a perverse way, the liquidity deficit is helping bonds rally,” said Gopikrishnan MS, head of foreign exchange, rates and credit for South Asia at Standard Chartered Bank in Mumbai. “Demand-supply is stacking up better post OMO from RBI.”

The liquidity deficit, which stood at one trillion rupees at the end of October, fueled a spat between the government and the RBI, with the former sending letters to the central bank citing powers the state has, which if invoked, could lead to the government directing the monetary authority to toe its line.

“Given the projected liquidity deficit over the rest of the fiscal period, OMOs might be necessary beyond November,” said Kuldeepsinh Jagtap, senior vice president at ICICI Securities Primary Dealership in Mumbai.

Inflation Easing

The brokerage’s base case favors a further 800 billion rupees of infusion after this month, he said.

With inflation seen easing over the next few months, swap rates aren’t pricing in more interest-rate increases, adding to the positive turn in investor sentiment. The RBI in October held borrowing costs after back-to-back hikes since June.

“At the short-end of the curve, markets are no longer pricing in a rate hike in December, instead pushing it forward to February and June,” according to a DBS Bank note.

The yield on the benchmark 10-year bond fell 17 basis points in October, its first decline in three months. It peaked at 8.23 percent in September, the highest level in four years.

“We expect a shallow rate hike cycle, easy liquidity and 750 billion-to-1 trillion rupees of OMOs after November until March end,” said Piyush Wadhwa, head of rates trading at IDFC Bank Ltd. in Mumbai.

Here are forecasts for the benchmark yield at year-end:

IDFC Bank                       7.85%

Standard Chartered       7.55% - 7.65%

Trust Capital                    7.60%

ICICI Securities PD        7.70%-7.80%

FirstRand Bank               7.60%