Government bond yields rose 4bps to 10bps across the curve week on week on the back of selling by and on the back of rising yields on SDLs (State Development Loans). The five and ten year benchmark bonds, the 7.28% 2019 bond and the 8.83% 2023 bond saw yields rise by 10bps and 6bps to close last week at levels of 9% and 8.85%. Government bond yields are at two months highs despite inflation coming off, GDP growth staying weak and the INR stabilizing at levels of Rs 62 to the USD.
The reason for government bond yields moving higher is the selling by mutual funds, which as a category sold around Rs 200 billion of bonds over the last few weeks. The market was not able to absorb this selling leading to bond yields rising. The states have not completed their borrowing for this fiscal and the last auction of Rs 85.30 billion saw bids worth Rs 76.50 billion being accepted at yields of 9.72% to 9.85% across states. SDL yield spread over ten year government bonds are trading at levels of 90bps to 100bps, which are higher than average spreads of 50bps seen a few months ago.
Mutual funds sold government bonds to create liquidity to meet redemptions for the month of March 2014. The fiscal year end increases demand for cash leading to investors redeeming investments in fixed income mutual funds. SDL yields are rising on the back of banks becoming unwilling buyers as the RBI could change a notification that allowed banks to value SDL at spreads of 25bps over corresponding maturity government bonds.
Banks bought SDL at market spreads (50bps to 100bps) and marked the spreads down to 25bps in their books, gaining 25bps to 75bps just by accounting. RBI is likely to curb this practice as it leads to artificial gains for banks on their SDL holdings. Hence banks are refraining from buying SDL given expected change in accounting rules, and this is leading to rising SDL yields.
Higher SDL yields are pulling up government bond yields as investors such as mutual funds who are unable to sell illiquid SDL are selling government bonds instead.
India’s third quarter GDP growth for fiscal 2013-14 printed at 4.7%, down from 4.8% growth seen in second quarter but up from 4.4% growth seen in first quarter. India’s full year growth estimates are at 4.9% and the country’s economy has to grow by 5.7% in the fourth quarter for growth to come in line with estimates.
RBI is unlikely to cut rates in the near future given that inflation as measured by the CPI (Consumer Price Index) is trending at levels of 8.79% against target levels of 8% for end March 2015. Inflation has come off from levels of 11.24% seen in November 2013.
The INR is holding steady at levels of Rs 62 to the USD despite the Fed tapering its asset purchase program by USD 20 billion since December 2013. Current account deficit expected at USD 45 billion for this fiscal is down 48% over last year. The government has brought down fiscal deficit to 4.6% of GDP from budgeted levels of 4.8% of GDP and has forecast a level of 4.1% of GDP for the coming fiscal. Lower is positive for the INR. FIIs have been net buyers of bonds for over USD 4 billion in the months of January and February 2014 given stable INR. FIIs have been largely buying treasury bills that are trading at over 9% yields.
Five and ten year benchmark AAA corporate bond yields rose 3bps each week on week while five and ten year credit spreads fell by 7bps and 3bps to close at levels of 59bps to 69bps respectively. Corporate bond yields are likely to stay at higher levels given expected tightness in liquidity.
market saw the curve shift up on the back of higher government bond yields. One and five year OIS yields rose by 3 bps and 8 bps respectively to close at levels of 8.68% and 8.56% and the five over one OIS spread flattened by 5bps to close at 12 bps levels. The spread could flatten further on the back of INR stability.