2020, the year that was: The best of bond rallies amid weak yields

Rupee among worst-performing Asian currency, but it supported Atmanirbhar campaign

The year 2020 caused widespread despair, but one group that cheered would be bond traders in India.

They could have easily become the worst-affected after the Covid-battered government pegged 2020-21's total borrowing at Rs 12 trillion. States followed suit with outsized borrowing plans of their own, estimated to be at least Rs 10 trillion.

The Rs 22-trillion borrowing was a mammoth task for a market that was used to accommodate just about half of this amount every year. But then came the Reserve Bank of India (RBI) with unprecedented liquidity support of Rs 11.11 trillion (until September) through various avenues; the governor of the central bank had a heart-to-heart talk with bond market participants from the monetary policy podium. Repo rates remained low, and fell by 115 basis points since March after it was left unchanged in the February policy.

The idea was to keep borrowing costs as low as possible for the government, and Governor Shaktikanta Das urged the bond market to have a view that was “competitive without being combative”.

The RBI walked the talk. And the yield on the 10-year government bond went below 6 per cent after the October policy and has remained there since. The RBI managed to conduct government borrowing at 16-year low average yields, brought down the spread between the corporate and government bonds to the pre-pandemic level, and pushed down short-term rates below 3 per cent —below the overnight policy rates. Banks — the largest investor group in government bonds —too, had a nice arbitrage.

Bond dealers say this may remain the state of affairs in the coming days, as well.

“Globally, bond yields will remain soft for some time, and there is no reason to believe that yields will rise out of sync in India. Important to remember here is that liquidity has remained plentiful since 2008 and it is unlikely to go away anytime soon,” said Jayesh Mehta, head of treasury at Bank of America.

Inflation, a key determinant of bond yields, should not be a cause for concern, say bond dealers. It is still driven by supply-side disruptions, which should correct as economic activities pick up and mobility gets restored.

Purely from a technical point of view, until the 10-year bond yield is above 5.5 per cent, it can rise until the key resistance level of 6.6 per cent. If the yield breaches 6.6 per cent, it can surge towards 7.3 per cent. However, a break below 5.5 per cent will push the yield towards 4.75 per cent, chartists say.

Rupee

CY20 was neutral for the rupee. The year also saw rupee OTC (over-the-counter) derivatives getting recognised by the RBI, part of inter-nationalisation.

The RBI's data show that the rupee volatility during Covid was the lowest in all recent crises. This is because of sustained intervention by the central bank, which accumulated about $100 billion in reserves this year. It also made the US Treasury put India on the currency manipulator watchlist, one of the criteria being keeping the currency weak through intervention.

Year to date, the rupee has been the weakest in the region — depreciating 3.07 per cent against the dollar, whereas its peers have largely appreciated. The rupee for a while endured protracted decline by hitting a record low of 76.90, succumbing to periods of volatility.

"In 2021, despite a viable vaccine, traders will keep their guards up due to a new coronavirus variant. The coronavirus variant will continue to hit India's exports in the markets like Europe, and substantially narrow the current account surplus. Also, there is a possibility of a revival in the US-China trade war under Joe Biden,” said Rahul Gupta, head of research-currency, Emkay Global Financial Services.

“The rupee has been the worst-performing Asian currency in 2020. The RBI has used the phase of dollar weakness to correct the rupee’s overvaluation, helping support the government’s 'Atmanirbhar' campaign by dis-incentivising imports. There seems to be a clear intent to keep the rupee weak, especially against the yuan,” said Abhishek Goenka, MD and CEO of IFA Global. The rupee has depreciated 13.3 per cent against the yuan in 2020, so far.

The RBI is expected to follow a similar path for the rupee in 2021, as well. But, the key risks of gradual rupee depreciation towards 76.50-77 are “US real rates falling further on account of further stimulus under the Biden administration and the prospects of Bond index inclusion,” Goenka said.

“In 2021, overall, the USD-INR trading range will be 71.50-76.30. As long as the USD-INR spot is trading above 72.75-73.00, the trend will be bullish with 74.50 being the key resistance. A break of 74.50 will open doors for 75.25 and then 76.30. While a break of 72.75 will push the spot price to 71.50-72.00 zone," Gupta said.