The government approved doubling of domestic gas prices last week and this is largely positive for the bond market. Domestic gas prices are at USD 4.2 mmBtu (million metric British thermal unit), well below the import price of USD 13 mmBtu. Gas prices are to be fixed at USD 8.4 mmBtu from 1st April 2014.
The government is a big beneficiary of the gas price hike. On one hand revenues from royalty from exploration will increase, as there will be increased interest in exploration for gas from upstream oil companies. Estimates on royalty are around USD 15 billion. On the other hand the government will earn from higher profits made by gas producers including ONGC and Reliance. Government will see higher tax revenues as well as higher dividend payouts from state owned oil and gas producers.
The hike in gas prices will lead to rise in price of domestic and industrial gas, power and fertilizers but that will be a one time increase after which prices will stabilize. Inflation could be impacted for a short while as prices increase. However the positive effects of higher domestic gas production will negate all negative effects of higher prices. The government could subsidize the power and fertilizer sector but it will make sure that the subsidies are not large enough to hurt the fiscal deficit.
The gas price hike will increase domestic production of gas and this will lead to a reduction in fuel imports. India imports 80% of its fuel requirements and oil imports contribute close to 35% of total imports. Lower oil imports can lower the trade deficit that in turn will lower the current account deficit (CAD)
The Indian Rupee (INR) will benefit from a lower CAD and a positive outlook for the currency can induce RBI to lower interest rates to boost a flagging economy. India’s economy grew by 5% in fiscal 2012-13, the lowest growth in a decade.
The INR received a boost from the release of the fourth quarter balance of payment data for fiscal 2012-13. CAD for the quarter came in at 3.6% of GDP, sharply down from record levels of 6.7% of GDP seen in the third quarter. The INR gained over 2% from record lows of Rs 60.73 to close last week at levels of Rs 59.42 post the release of the CAD numbers.
Government bond yields fell from highs seen during the week on the back of the INR recovery. The ten year benchmark bond, the 7.16% 2023 bond saw yields coming off from highs of 7.58% seen during last week to levels of 7.45% on the back of the INR trending up from lows. Bond yields had surged by 15bps before coming off as the INR touched record lows against the USD.
Government bond yields are likely to trade with a positive bias in the coming weeks as the market buys into yields at higher levels.
Corporate bond yields surged last week with benchmark five and ten year AAA corporate bond yields rising by 23bps each. Credit spreads rose with five and ten year AAA credit spreads rising by 16bps and 20bps week on week. Corporate bond market worried about FIIs pulling money out of the debt market on the back of a weakening INR.
Corporate bonds should see buying at higher levels of yields as the INR stabilizes.
OIS (Overnight Index Swaps) market saw the yield curve move up with one and five year OIS yields moving up by 5bps each week on week. OIS yields are likely to trend down on the back of INR stability.
Liquidity as measured by bids for repo in the LAF (Liquidity Adjustment Facility) of the RBI eased last week as banks demand for funds decreased in the reporting week. Bids for repo averaged Rs 65,000 crores on a daily basis last week against as average of Rs 68,000 crores seen in the week before last. Liquidity is likely stay at levels of Rs 65,000 crores in the coming weeks given lack of strong inflows or outflows.