After remaining range-bound for many months, sovereign bonds market performed well since November 2012, primarily on the back of improved demand-supply dynamics and monetary easing expectations. One of the biggest worries of the bond markets was the expected slippage on the fiscal deficit front and hence, the resultant borrowing over and above that budgeted for FY2013. However, significant clampdown on expenditure by the government helped it stick to its original scheduled borrowing plan. This resulted in a significant rally in bonds, towards the year-end (CY12).
January saw the continuation of the bond market rally with monetary easing expectation aiding the bonds. In line with market expectations, the Reserve Bank of India (RBI) delivered 25 basis points (bps) cuts each in repo rate and cash reserve ratio. The forward guidance kept open the possibility of further rate cuts. The 25 bps CRR cut will infuse about Rs 18,000 crore into the banking system.
This rate cut came after nine months of wait. The most notable aspect of the policy announcement on January 29 was that RBI adopted a cautious, yet pro-growth stance. Given the extraordinary nature of the economic cycle — high inflation combined with lower growth — it is well on expected lines that the current rate cut cycle is a slow one. This, along with various macro-economic risks, especially twin deficits still looming, the rate cut cycle will continue to be a slow one even in future. One of the interesting features of the current monetary easing cycle is the RBI’s support to the economy through various liquidity infusion measures such as CRR cut and bond buybacks (open market operations), which goes a long way in supporting bond market dynamics.
As far as the yield curve dynamics is concerned, two- to five-year tenor bonds are likely to benefit the most from the monetary easing expectations and RBI’s proactive approach in infusing liquidity. Another important feature that impacts the yield curve is the supply of government bonds. The supply of government bonds is usually concentrated in 7-15 years-part of the curve and, therefore, two-to five-year bonds are likely to outperform the rest of the yield curve. The expected seasonal improvement in liquidity conditions in the first half of the fiscal year beginning April, should also be supportive of money market rates and the shorter end of the corporate curve.
Overall, bond markets are likely to perform well this year. Along with monetary easing, the low credit growth environment should keep the demand for sovereign bonds from the banking system quite high. In this respect, demand for sovereign bonds from the RBI, in the form of open market operations, should also aid the demand-supply dynamics. Bonds will also benefit from the RBI’s recent formalisation of the increase in foreign institutional investor limits to $15 billion from $10 billion earlier. Overall, eight per cent plus levels are attractive on valuations in 10-year sovereign bonds and should be used as one of the benchmarks to accumulate bond positions. We expect 10-year bond yield to touch 7.50 per cent in calendar year 2013. In this backfrop, we expect all debt market funds to perform well over the year.
The author is India fixed income strategist, Nomura Financial Advisory
