The government released the withholding order on the railway passenger fare and freight rate hike to make it implementable on the 25th of June. The previous government had passed the railway fare hike but had placed the withholding order on the 16th of May, when the 2014 election results were announced. Passenger fares are to be hiked by 14.2% while freight rates are to be hiked by 6.5%.
At the outset, the fare hikes seem inflationary in nature, as it will push up cost of goods transported by railways. However the fare hike is seen as a precursor to a tough budget by the Modi government in July. Bond markets will welcome a budget that tries to reduce subsidy, rationalize consumption, raise revenues and spend on creation of infrastructure.
Bond yields rose last week as markets took risk off the table on worries of rising oil prices due to civil war in Iraq. Brent crude prices touched multi year highs on the back of Iraq tensions. Weak monsoons, EL Nino and railway fare hikes added to worries on inflation.
Ten year benchmark government bond yield rose 12bps week on week with the 8.83% 2023 bond yield closing at 8.72% levels. The newly issued 8.60% 2028 bond saw yields rise by 15bps to close at 8.63%. The five year benchmark bond, the 7.28% 2019 bond saw yields rise by 19bps to close at 8.59% levels.
Government bond yields will stabilize at current levels and look to come off on expectations of a fiscally prudent budget.
OIS market saw the yield curve move up week on week on the back of rising government bond yields. One and five year OIS yields rose 9bps and 14bps to close at levels of 8.34% and 7.94% respectively. The five over one OIS spread flattened by 5bps to close at negative 40bps levels.
OIS yields are likely to trend down going forward given expectations of improving liquidity conditions in July as government spends on projects and on the back of the Fed sounding benign on policy. The Fed cut bond purchases by USD 10 billion and sounded out gradual rate hikes starting 2015. Ten year US treasury yields fell post Fed policy.
Corporate bond yields rose following government bonds with five and ten year AAA corporate bond yields rising by 14bps, 13bps and 10bps each respectively. Credit spreads fell marginally with five year and ten year spreads falling by 1bps and 3bps each to close at 24bps and 44bps levels respectively. Ten year AAA credit spreads at 24bps are extremely tight reflecting the kink in the government bond yield curve that is awaiting the issuance of a new ten year benchmark bond.
Liquidity tightened this week on advance tax outflows with banks borrowing Rs 965 billion from the RBI against a borrowing of Rs 870 billion seen last week. Liquidity is likely to ease going forward as the government spends its surplus post budget.