The ten year benchmark bond yield can potentially fall by 100bps in the coming months. The yield on the current on the run bond the 8.79% 2021 bond is at 8.35% levels and its yield will fall to 7.35% levels if the current trend of record low global bond yields continues. Indian bonds have severely underperformed its global counterparts in the last one year and given the current market conditions, Indian bonds are likely to benefit from the sharp fall in bond yields across the globe.
Bond yields of the US, Germany, UK, France and Japan have fallen considerably over the last one year are now trading at record lows. Table 1 shows the performance of global ten year bond yields over a one year period.
India is the only country amongst those listed in Table 1 where bond yields have actually gone up. The reason for Indian bond yields underperforming over the last one year is a) Government exceeding its budgeted fiscal deficit for 2011-12 by 1.3% b) RBI raising policy rates by 125bps to fight inflation which was trending at over 9% levels for the whole of calendar year 2011 and c) Liquidity being tight with banks consistently borrowing well over 1% of their NDTL (Net Demand and Time Liabilities) from the RBI on a daily basis to meet their day to day fund requirements.
The record low levels of bond yields from the US to UK and Japan is due to a) risk aversion to bonds of indebted sovereign countries in the Eurozone leading to banks and investors shifting out of bonds of countries such as Italy and Spain and moving into bonds of relatively safe countries of Germany and France b) central banks of US, UK and Japan buying bonds to infuse liquidity and stimulate growth in their economies and c) worries on global economic growth leading to fall in inflation expectations and fall in interest rates.
It is time for Indian bonds to start performing
The conditions for Indian bonds to start rallying are good. The first sign of the market turning around its view on Indian bond yields was the sharp fall in yields post the release of the fourth quarter 2011-12 GDP numbers. The yield on the ten year benchmark bond fell 14bps from 8.51% levels to 8.37% levels after the GDP growth number of 5.3%, which was a nine year low, was released. The markets started factoring in rate cuts by the RBI in its June 18th policy review on the back of the weak GDP growth number.
The market sentiment is turning bullish on the back of sharp fall in oil prices globally with Brent crude down over 25% from highs seen over the last one year. The fall in oil prices negates the inflationary effects of the fall in the Indian Rupee (INR), which has fallen by over 20% over the last one year.
Government bond supply, with the government borrowing a record of Rs 479,000 crores in fiscal 2012-13 was a concern at the beginning of the fiscal year 2012-13. The concern over the absorption of the supply has reduced on the back of RBI buying Rs 50,000 crores of bonds fiscal year to date to infuse liquidity into the system. Bond traders are in fact running below optimum bond positions as the markets has had to absorb only Rs 33,000 crores of the total supply of Rs 142,000 crores of government bonds auctioned fiscal year to date. Bond redemptions of Rs 59,000 crores plus RBI purchases of Rs 50,000 crores has negated most of the supply.
RBI bond purchase has reduced the worries of liquidity tightness. Banks are borrowing in a range of Rs 75,000 crores to Rs 110,000 crores from the RBI on a daily basis and this borrowing is likely to reduce on the back of infusion of liquidity by the RBI.
RBI may or may not cut rates in its June 18th policy review but the markets will start to factor in more rate cuts for the whole of fiscal 2012-13. Signs of economic weakness post the GDP growth numbers will give rise to expectations of a 100bps to 150bps repo rate cut from current levels of 8%. The rate cut expectations will drive down ten year bond yields and it is a good time for investors to increase maturity of their fixed income portfolios.