ICRA expects gross bond issuance vide Government of India securities (G-sec), State Development Loans (SDL), UDAY bonds and municipal debt to remain stagnant at Rs. 10.7 trillion in FY2018.
However, growth of corporate bond issuance is estimated to remain substantial at 20 to 22 percent in FY2018, with gross issuance rising to Rs 8.5 trillion, which may exert pressure on spreads vis a vis G-Sec.
"ICRA expects total gross bond issuance by the three tiers of government of Rs. 10.7 trillion in FY2018," said Group-Head-Financial Sector Ratings ICRA, Karthik Srinivasan.
"Although the 10-year G-sec yield has reverted to the level seen before the note ban, SDL yields are now 20 bps higher than the level recorded in the auction on November 8, 2016, following the announcement in mid-January 2017 of the exclusion of most states from utilizing National Small Savings Fund (NSSF) inflows to fund their fiscal deficits. Moreover, AAA corporate bond yields are around 10 bps higher than the pre-note ban level. While ICRA expects bond yields may soften from current levels in the event of a rate cut, higher supply of SDL and corporate bonds may widen their spreads relative to G-sec," he added.
The gross dated borrowings of the Government of India (GoI) are expected to remain flat at Rs. 5.8 trillion in FY2018, as indicated in the Union Budget.
However, ICRA estimates the gross market borrowings of the state governments to rise by 22 percent from Rs. 3.7 trillion in FY2017 to Rs. 4.5 trillion in FY2018, on account of larger fiscal deficits, a spike in debt repayment from FY2018 onwards and the exclusion of most states (except Madhya Pradesh, Kerala, Arunachal Pradesh and Delhi) from investing in the NSSF from April 1, 2016.
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Moreover, urban local bodies are expected to make a cautious re-entry into the bond markets, with municipal bond issuance expected to remain under Rs. 0.2 trillion, to fund their share of projects under Smart Cities and Amrut.
In contrast, the UDAY bonds issued by states to replace their Discoms' debt from banks, would taper off in the immediate term, with most states likely to complete such issuance in FY2017; ICRA estimates that UDAY bond issuance would decline to Rs. 0.2 trillion in FY2018-FY2021 from Rs. 1.2 trillion in FY2017. As a result, ICRA expects the total gross bond issuance by the three tiers of government to remain steady at Rs. 10.7 trillion in FY2018.
Benefitting from finer pricing in the bond markets, ICRA expects the year-on-year (YoY) growth of corporate bonds to remain substantial at 20 to 22 percent in FY2018. In absolute terms, the gross corporate bond issuance is expected to increase to Rs. 8.5 trillion in FY2018 from an estimated Rs. 7.1 trillion in FY2017.
Despite the hawkish stance of the policy document, the MPC members' verbal comments emphasized that the policy stance is flexible. This suggests that one last rate cut of 25 bps to bring the repo rate to 6.0 percent should not be ruled out, given the stance that real interest rates may need to be around 125-175 bps, although the likelihood of further easing appears low.
A rate cut would dampen bond yields, as well as foreign institutional investors' (FII's) interest in Indian debt, particularly in the light of the expected rate hikes by the US Federal Reserve. However, banks interest in investing in bonds is expected to remain high, given subdued demand from the private sector for bank credit, in light of sluggish capital spending and less attractive bank lending rates.
While ICRA expects bond yields may soften from current levels in the event of a rate cut, higher supply of SDL and corporate bonds may widen their spreads relative to G-sec.