Rate cuts may help sovereign bonds post modest gains despite fiscal woes

Bond Bulls in India Bet on Rate Cuts to Counter Fiscal Worries

More rate cuts from Asia’s most accommodative central bank this year will help India’s sovereign bonds post modest gains despite the lingering fear of the government missing budget targets.

The yield on the new 10-year bond due in 2029 is likely to drop to 6.38 per cent by December-end, and further to 6.30 per cent by March, according to the median estimates in a Bloomberg survey of 12 traders and fund managers. It rose four basis points to 6.51 per cent on Friday.

The $20 billion tax break to companies and the sluggish growth in revenue have led to concerns about the government adding to its record borrowings. At the same time, the central bank has pledged further easing if needed after delivering five back-to-back cuts to boost growth, helping steady the market after a two-month sell-off.

“The possibility of extra borrowings will be a factor that the market will continue to watch,” said Shailendra Jhingan, chief executive at ICICI Securities Primary Dealership Ltd. “But the monetary policy would continue to support yields, primarily at the short end of the curve.”

The government plans to sell Rs 2.68 trillion ($38 billion) of debt in the six months that began Oct. 1. While the size is unchanged from what was announced previously, the administration aims to end the borrowings in January -- two months before the fiscal year ends.

This window can be used to squeeze in extra bond sales, traders say. Finance Minister Nirmala Sitharaman has said she would take a call on the year’s fiscal-deficit goal closer to the federal budget in February.

Following are comments from traders and fund managers:

IDFC Asset Management (Suyash Choudhary, head of fixed income)

• Scope for some expenditure cut exists but still looking at about 40bps of slippage on the fiscal deficit target. Estimating about Rs 50,000 crore of extra bond supply.
• Steeper curves are a logical outcome of the two forces at play: on the one hand, policy rates are going to be lower for longer, and on the other, there’s considerable fiscal and bond-supply risk especially when states are considered as well.
• Bullish for rates up to 5 – 7 years as expect some sort of bull steepening to continue.

Edelweiss Asset Management (Dhaval Dalal, head of fixed income)

• Constructive on liquid, high-quality and long-maturity bonds.
• The hunt for yield is powerful as investors look for opportunities to deploy investment surpluses as companies deleverage and hold back fresh investments.
• With this backdrop, investors will be happy to consider investing in long maturity state companies’ bonds at current levels due to their perceived safety, liquidity and superior risk-adjusted returns.

Quantum Asset Management (Pankaj Pathak, fixed-income fund manager)

• Fiscal developments will continue to be a drag for the next six months. The government has announced a borrowing calendar, but it seems the market does not believe the numbers.
• Sees room for repo rate going below 5 per cent as most steps taken by the government are non-inflationary. Fiscal breach is not because of higher expenditure but lower revenue.
• Positive on sovereign bonds because the fiscal impact is limited. Yields will head down by 30-40 basis points.

ICICI Securities Primary Dealership (Shailendra Jhingan, chief executive)

• Expects the yield curve to keep steepening. Remains overweight on short-end bonds till the time the growth continues to remain weak and below potential.
• As a result of the shortfall in revenues, the fiscal deficit may end up in the 3.6-3.8 per cent range. However, this does not mean large extra borrowings as the government can cut back on buybacks and increase T-bill issuance to meet some of the shortfall.
• Expect 25-40 basis points of further rate cuts in the year.