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The rally in Indian bonds' prices is likely to sustain in the coming months, as the Reserve Bank of India (RBI) is expected to overcome its fear of inflation and cut interest rates sooner than later. Abating inflationary pressures and falling global commodity prices are fuelling rate cut hopes that led to the benchmark 10-year government bond yield drift south to a 15-month low earlier this week.
The banking regulator, however, might not lower its guard on inflation and cut rates in a hurry this calendar year. But that does not appear to dent investors’ sentiment. “I don’t think there will be too much of a disappointment if there is no rate cut on December 2 (when RBI will review its monetary policy). The market appears convinced that rates will be reduced soon,” said Harihar Krishnamoorthy, treasurer at FirstRand Bank in India. He expects the 10-year bond yield to touch 7.75 per cent in the medium term from its current level of 8.17 per cent.
Bond yield and prices are inversely correlated. A fall yield will mean higher bond prices and vice versa.
Bankers claim the recent rally in bond prices has also been supported by foreign investors, who have been strong buyers of debt as rate cut hopes resurfaced following the drop in consumer price index-based (CPI) inflation to 5.52 per cent in October, its lowest rate since the government started releasing the data in February 2012.
“It is no longer a question of whether RBI will cut rates; it is now just a question of when. Investors are now more confident and that confidence will not be affected if RBI keeps rates unchanged next month. The rate cut cycle is expected to be faster and deeper,” said Rohit Bhasin, head of fixed income and currencies at Deutsche Bank in India. He predicts the 10-year bond yield to touch 7.70 per cent by the end of March, if not earlier.
While bankers and analysts expect RBI to stay ‘dovish’ in its policy review next month, they also anticipate the central bank to recognise the improving macro economic factors. Mere acknowledgement of the easing inflationary situation is sufficient to push up bond prices further, they said.
“Inflation, notwithstanding its base effect, is at a historic low. There is complete collapse in the global commodity prices. The macro factors have changed radically – the current account deficit is under control, fiscal deficit position is in line with projection and we have a surplus balance of payments situation. The market is expecting RBI to at least acknowledge the improvements in macro economic indicators. That will give investors the confidence and help sustain the rally,” said Bhasin.
