Expect bond yields to edge higher this week: Mahendra Jajoo

The FY14 Budget presented last week further emphasised on the need for continued fiscal consolidation. Actual fiscal deficit for FY13 came in at 5.2%, lower than the stated target of 5.3%. Further, the FY14 target was projected at 4.8%. Most analysts though opined that the revenue projection appear stretched, particularly the nominal GDP growth projections of 13.4%, around which the rest of the arithmetic revolves. Financial markets generally sold off in disappointment with equity, bond and currency markets all closing deeply in red for the week. In addition to lack of visibility of revenue growth as projected, high government borrowing, no clarity on measures to deal with current account deficit and reviving investment climate were the areas of disconcert. However, the negativity surrounding the budget may be the market's own impatience in discounting most optimistic scenario too early and then suffering from indigestion in haste. From all indications, there seems to be a fresh start in addressing all difficult issues by the government. The ground economic situation is extremely challenging, particularly on the external front where continued high current account deficit can potentially take the country very fast to a 1991-like situation. At this point there is no room for heroics and dramatic measures, but a need to be pragmatic and sincere and that is apparent from the current policy framework making one cautiously optimistic.

 
Benchmark 10-year gilt yields inched up 10 basis points (bps) after the budget announcement. As mentioned in last week's column, this volatility was to be expected in view of the pre-budget rally. Given the current negative sentiments, bond yields are expected to move up further in coming week with a possibility of touching the 8% mark.

The GDP for Q3FY13 came in at 4.5%. With a tight leash on government spending in the current quarter, GDP growth is expected to remain subdued for some time. Ground conditions remain supportive for a further rate cut by RBI in March policy review. Investment climate remains pathetic, inflation is trending down and fiscal consolidation is underway. However, given the reversal in market momentum, notwithstanding a rate cut, bond yields will find it difficult to breach the previous month's low of 7.80%. As such, the trade idea would be to accumulate in the current sell-off with a view to book profits in case of a rate cut. Short term rates will continue to tighten up in March due to cyclical increase in demand for funds. As the large cash balances with government are expected to flow back in system in April, here again, accumulating a high accrual portfolio will be the correct approach.