For the time being, the RBI manages market forces by lowering bond yield, but how far can it go given India’s record borrowing?

For the time being, the Reserve Bank of India’s loose monetary policy and two back-to-back bond auction cancellations have lowered rates, but it remains to be seen how far and how long it can keep them down, especially in light of India’s anticipated record borrowing next year. As the government prepares to finance its massive borrowings in the fiscal year 2022-23, “the domestic bond market appears to be trapped between a rock and a hard place mixed with fat-tailed uncertainty,” according to Vivek Kumar, an economist at QuantEco Research. The rates on 10-year benchmark bonds are expected to stiffen in the next few days, according to experts.

On the one hand, global risks, such as rising commodity prices, have prompted several global central banks, notably the US Federal Reserve and the Bank of England, to tighten their policies. The RBI, on the other hand, has not felt compelled to follow the lead of its overseas counterparts because of its dovish inflation forecast. “While the RBI’s lagged and liberal policy normalization will provide some relief, a record high borrowing pressure in FY23 (in the absence of active OMO purchases by the central bank and expectations of subdued appetite from FPIs) will weigh on bond market sentiment,” Vivek Kumar said.

After the national government announced higher-than-expected borrowings of Rs 14.95 lakh crore in the budget on February 1, bond rates surged to 6.9%. Yields finally fell to 6.72 percent after the government postponed a bond auction scheduled for February 11 and the central bank’s Monetary Policy Committee maintained its dovish stance.

How will the curve’s long end perform?

“Due to huge market borrowing intentions and inflation fears, the long end of the yield curve will stay under pressure.” While liquidity circumstances and the RBI’s monetary policy stance would influence the short end, according to Laxmikant Lokhande, the senior debt analyst at HDFC Securities. In bond markets, monetary policy has historically influenced the short end of the curve, whereas demand supply and inflation have influenced the long end of the curve, i.e. benchmark 10-year bond rates.

QuantEco forecasts a hardening of rates from present levels, with the 10-year benchmark government bond yield reaching 7.25 percent by the end of the fiscal year 2023. Lakshmi Iyer of Kotak Mahindra Asset Management forecasts rates to hover between 6.65 percent and 6.75 percent in the short future. According to a Bloomberg poll of 12 traders and analysts, India’s sovereign bond relief rally might expire in a few weeks, with 10-year bond yields rising to 6.75 percent by the end of the first quarter and 7.23 percent by the end of December.

Cancellation of G-sec auctions 

So far, the government has canceled securities auctions worth roughly Rs 63,000 crore, including back-to-back weekly G-sec auctions scheduled for February 11 and February 18. The RBI also announced last week that the sale of the remaining gilt switch for the current financial year has been canceled since the government’s budget goal for the year has been met, according to the central bank.

Following the cancellation of the previous two auctions, the central bank has set a Rs 23,000 crore government securities auction on Friday, February 25. As a result, on Tuesday, rates climbed five basis points to 6.74 percent. The real test for the bond market will come after the central bank announces the schedule for G-sec auctions for the coming fiscal year.

“The motivation for canceling the remaining two scheduled weekly G-sec auctions, as well as the switch procedures, is to anchor bond market sentiment,” Kumar of QuantEco explained. While this is the obvious consequence on the front end, he continued, the back end is increased fiscal comfort from solid revenue collections, a realistic possibility of LIC disinvestment completion by the end of March 2022, and higher-than-expected revenues under modest saving programs.

According to Lakshmi Iyer, CIO – Debt & Head – Products at Kotak Mahindra Asset Management Company, bond markets have been robust to the last RBI MPC meeting as well as bond cancellations, and the signal from the government to the money markets has been pretty clear. It is also a wise option, she noted, given the government’s financial levels.

Outlook for domestic fixed income market

“While interest rates are anticipated to rise in the domestic fixed income market, the pressures are likely to be mild, and considerably lower than what India sadly experienced during the 2013 Taper Tantrum incident,” Kumar of QuantEco said. “Most global debt investors may continue to find India appealing on a risk-adjusted carry basis,” he said, adding that extreme withdrawals are unlikely.


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