The bond market got over its initial disappointment of RBI holding rates status quo in its policy review meet in July to take down bond yields by 5bps to 8bps on fresh hopes of rate cuts. The ten year benchmark bond, the 8.15% 2022 bond saw yields drop by 8bps from highs of 8.25% to close last week at 8.17%. Bond markets reacted to a statement by the new FM, P. Chidambaram who said that fiscal and monetary policy should work in tandem. The negative IIP (Index of Industrial Production) growth of 1.8% in June 2012 against a positive 2.5% growth seen in May 2012 added to rate cut expectations. Manufacturing growth for June was at a negative 3.2% against a growth of 2.6% seen in May.
The rate cut expectations was however tempered by worries of the government revising its fiscal deficit targets for 2012-13. The fiscal deficit for 2012-13 is budgeted at 5.1% of GDP but with GDP growth estimates being revised downwards by the RBI from 7.3% to 6.5%, the fiscal deficit will be revised upwards, unless the government curbs expenditure drastically. Expenditure curbs are not likely to happen given weak monsoons and given the sharp losses of public sector oil marketing companies such as IOC (Indian Oil Corporation), which saw losses for the first quarter 2012-13 at a record Rs 20,000 crores. The government has to pay for the losses incurred by OMC’s and this will place a strain on government finances at a time when revenues are slowing. Direct tax collections have grown by just 4.7% in the April-July 2012 period, indicating the sluggish growth in revenues.
The market is now torn between rate cuts and prospects of higher government borrowing. RBI has indicated that it will stick to the borrowing calendar given out at the beginning of the year but markets will be fearful of additional borrowing for the second half of fiscal 2012-13. The government finances are strained with the government overdrawn with the RBI by around Rs 21,000 crores. RBI paid dividend of Rs 16,000 crores to the government last week and this will bring down the government overdraft with the RBI.
RBI will look at the inflation numbers for July 2012, before taking a call on rate cuts. July 2012 inflation is expected to come in at around 7.4% against levels of 7.25% seen in June 2012. If inflation comes in lower than expectations, markets will position for rate cuts in RBI’s September 2012 mid quarter policy review.
Government bond yields will look to trade in an 8% to 8.20% range as the market goes into RBI’s September 2012 policy review.
Liquidity as measured by bids for repo in the LAF (Liquidity Adjustment Facility) auction tightened last week as banks demand for funds increased in the last week of the reporting fortnight. Bids for repo averaged Rs 44,000 crores on a daily basis last week against an average of Rs 39,000 crores seen in week before last. Liquidity is likely to be in an Rs 20,000 crores to Rs 40,000 crores deficit in the coming week as banks cover their product in the first week of the reporting fortnight.
Interest rate swap market saw the yield steady on the back of rate cut expectations. One year OIS (Overnight Index Swap) yields was flat while five year OIS yields fell 3bps week on week. OIS yield curve will look to trend down if inflation for July comes in below expectations.
Corporate bond yields fell by around 3bps week on week on the back of easing government bond yields. Five and ten year benchmark AAA credit spreads closed last week at 94bps each. Corporate bond yields will stay steady at current levels with credit spreads moving on movement in government bond yields.
Government bond auctions
The government auctioned Rs 15,000 crores of bonds last week. The bonds auctioned were the 8.07% 2017 for Rs 4000 crores, the 8.15% 2022 bond for Rs 6000 crores, the 8.97% 2030 bond for Rs 3000 crores and the 8.33% 2036 bond for Rs 2000 crores. The cut offs came in at 8.13%, 8.17%, 8.52% and 8.58% respectively. The government is scheduled to auction Rs 15,000 crores of bonds this week.