The auction cut off on the benchmark ten year government bond, the 7.16% 2023 bond, came in at 7.28% levels. The government had issued the new ten year bond two weeks ago where the coupon was set at 7.16%. The yield on the 7.16% 2023 bond had gone down to levels of 7.10% in the beginning of last week before climbing all the way up to levels of 7.28% in the auction.
The question the market will ask as it goes into trading this week is whether the yields on the 7.16% 2023 bond has seen its lows and yields can only rise from here or is there still a long way for yields to go down? The market will look at the following factors to judge whether bond yields can still go down or not.
One of the primary reasons for the sharp rise in bond yields from lows is the fall in value of the INR against the USD. The INR lost 1.5% against the USD over the last one week and is trading just over a percent from all time lows seen in June 2012. The fact that bond yields had trended down sharply by 40bps over a month to trade at three and half year lows drove markets to sell bonds at lower levels of yields on the back of the weakening INR. A weak INR lends fears to inflation, CAD (Current Account Deficit), tight liquidity and RBI becoming hawkish.
The fact is that the INR is unlikely to add to inflation fears given that commodities prices are down sharply across the globe. Oil prices are down over 8% since April 2013 while the benchmark commodity index the Reuters CRB commodity index that tracks a basket of 19 commodities is trading at close to its lowest levels since June 2012.
Inflation for the month of April 2013 came in at a three and half year low of 4.89% and inflation outlook is benign. India’s economy grew at levels of 4.8% for the fourth quarter of 2012-13 and with GDP growth at decade lows of 5% for full year 2012-13, there is no case for inflation trending up due to rising aggregate demand.
CAD is a worry given the over 70% rise in trade deficit for April 2013 but expectations are that a weak INR coupled with slowdown in economic growth will bring down the CAD in fiscal 2013-14. Capital flows are robust with FII investments at USD 6 billion for the first two months of this fiscal.
The government’s fiscal deficit target of 4.8% of GDP is likely to be met with the government’s efforts to curb expenditure. Lower subsidy bill due to fall in oil prices and steady pass through of diesel prices to the end user will keep down the deficit. The government’s fiscal deficit for 2012-13 was 4.9% of GDP against budget estimates of 5.2% of GDP. The government is unlikely to increase borrowing for this year given its healthy cash position of Rs 100,000 crores.
Global economic conditions are weak with IMF lowering China’s growth forecast. Eurozone is in recession. US is the only economy that is steadily picking up in pace but there are hardly any signs of overheating. The Fed is likely to cut its bond purchases going forward and this is positive for inflation globally.
Given the factors mentioned above, INR bonds are likely to start trending down after positions have been readjusted in the market.