Barclays recommends staying long in bonds on policy support

The British investment bank expects the yield on 10-year government bonds to move towards 7.5 per cent over the medium term

British investment banking firm Barclays expects the yield on 10-year government bonds to move towards 7.5 per cent in the medium term; the government securities were trading at 8.16 per cent at the close of market hours on Friday.

However, the bank recommends being long on government securities as it expects policy support for bonds to increase going forward.
“We think that the RBI will likely buy Rs 1.5-1.7 lakh crore bonds and cut repo rate by 100 basis points over the reminder of this fiscal year,” said Kumar Rachapudi, an analyst with the bank in a research report issued today.

As per the bank’s estimates Rs 1.25 lakh crore of primary liquidity injections are needed to meet the needs of increasing currency demand and increase in reserve requirements.

The RBI currently has $14.5bn of foreign exchange forward swaps outstanding. As per the estimate the bulk of the maturities will occur over January-May 2013.

“The net impact of these maturing swaps will be to remove rupee liquidity, which, we think, the RBI is likely to offset, given its stance of maintaining stable liquidity conditions,” said the report.  “We think that Rs 25,000-50,000 crore of these maturing swaps will be offset using open market purchases of bonds,” the report added.

Barclays expects banks to absorb more than Rs 1.5 lakh crore of bond supply, including state loans and treasury bills before March 2013. The low credit growth (constrained by high interest rates) and increased risk of non performing loans is likely to motivate banks to hold more bonds on their books. Separately, seasonal increases in deposit base is likely to increase banks' demand for bonds in October.