Bond yields could drop to 8% in 6 months

Government bond yields are seen falling on expectations of a rate cut this financial year, due to a fall in retail inflation. Experts say the yield on the 10-year benchmark bond might fall to 8.25 per cent in a month and eight per cent in six months.

So far, Reserve Bank of India (RBI) Governor Raghuram Rajan hasn't given any hint of a rate cut. He has set an inflation target of six per cent by January 2016.

The bond market, however, expects RBI to cut the repo rate by March-end 2015. The repo rate, or the rate at which banks borrow from the central bank, has been eight per cent since the beginning of FY15.

"Oil prices are coming down. Diesel has been de-regulated and the inflationary impact from lower diesel prices will be positive. With lower fuel prices, the government's subsidy burden should fall. The probability of meeting the 4.1 per cent fiscal deficit target is higher," said Badrish Kulhalli, head of fixed income at HDFC Life.

Currently, the yield on the 10-year bond is 8.36 per cent, the lowest in about a year. At the beginning of this financial year, the yield had breached nine per cent.

RBI's fifth bi-monthly monetary policy review is scheduled for December 2. "In anticipation of the December monetary policy, bonds yields may soften further. We expect yields to soften and the 10-year bond yield might fall to eight per cent in six months," said R Sivakumar, head (fixed income), Axis Mutual Fund.

In September, Consumer Price Index-based inflation stood at 6.46 per cent, the lowest since January 2012, owing to a fall in the prices of fruits and vegetables. "Every improving inflation number is giving more confidence to the bond market," said Lakshmi Iyer, chief investment officer (debt), Kotak Mutual Fund.

Banks might continue buying bonds. N S Venkatesh, executive director and head of treasury at IDBI Bank, says with a benign inflation outlook, comfortable liquidity and not much credit offtake, the yield on the 10-year bond might fall to 8.25 per cent in a month.