Debt monthly view for January 2020

February 6, 2020
Quantum Fixed Income Team

With the two big events, Budget and the monetary policy outcome through, the direction and the trajectory of the bond markets and thus bond yields seem clear.

The 10 year government bond yield had traded in a narrow band of 6.5%-6.7% in January, awaiting the outcome of these two events. Bond markets went into the budget hoping that a) the government does not announce a very large extra borrowing in FY 20; b) the government limits the fiscal deficit in FY 21 to 3.5% of GDP and c) having done so, works out some means of higher foreign participation to buy the excess government bonds on supply.

The government delivered on all 3 aspects:
a) The government increased the fiscal deficit for FY 20 to 3.8% of GDP from the budgeted 3.3% of GDP, but still did not announce any market borrowing; by resorting to higher funding from Small Savings
b) The government managed to budget the fiscal deficit for FY 21 at 3.5% of GDP; by announcing that they will increase disinvestments to INR 2 lakh crore, by selling stakes in BPCL, Air India and launching a IPO for LIC (Life Insurance Corporation)
c) The Government also announced issuance of special government securities, which will not have any upper cap on foreign participation, hoping that such a move would allow Indian government bonds to be included in global bond indices. This if it happens, it will be a big move and would make global funds which track these bond indices to invest in those Indian bonds., and thus reducing the demand from local / domestic sources.

The Bond market reacted positively to the above and the 10 year government bond yield moved down by 10bps (0.1%) post the budget.

The next outcome was from the RBI monetary policy. The markets were expecting the RBI to keep the Repo Rate unchanged at 5.15%, given the increase in near term inflation, but the bond market was hoping for other measures to support the bond market and aid in monetary transmission (such that) the benefit of the lower Repo Rate is also passed on to lower bank lending rates.

The RBI announced that they would begin a Long Term Repo Operations, of INR 1 lakh crore (1 trillion), of 1 and 3 year tenor. This is a big move as this ensures that banks can access 3 year funds at the current Repo Rate of 5.15% and use it to either buy government bonds, corporate bonds or lend to companies. Not only, does this move assure the market of funds at lower rate for a confirmed period, it should also trigger a fall in short term bond yields and short term lending rates from banks.

This move, we believe can have a bigger impact in monetary transmission than rate cuts. Anyways, with the CPI inflation trajectory, we do not expect the RBI to cut the Repo Rate anytime soon. So, the RBI also has chosen to focus on trying to get lending rates lower, and the above move is a step towards that.

We continue to hold a neutral view on the bond markets and as we have mentioned before, with 10 year bond yields around 6.5%%, we still do not see any structural investment play in bond funds. Developments on the inflation front and oil prices will determine whether long term bond yields drop further or have seen the best in the bond markets.

Given the excess liquidity situation, which we expect to continue, returns from overnight and liquid funds will remain muted.

As always, investors in bond fund should prioritize safety and liquidity over returns and should invest in bond funds only with a long term time horizon and keeping in mind that in the short term returns from bond funds may be volatile and may also be negative.

Data Source: Bloomberg, RBI

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