Revived rate cut hopes lead to fall in bond yields

10-year bond yields seen near 8.10% before RBI's next policy review

The rally in the bond market picked up again on hopes of a rate cut by the Reserve Bank of India (RBI) as early as next month, following comments by Finance Minister Arun Jaitley on Monday and continued inflows from foreign investors.

Jaitley had said if RBI brought the repo rate down in the monetary policy review scheduled on December 2, it would provide a “fillip” to the economy.

Banks have been the biggest buyers of government bonds, as credit growth has been muted. The festive season, too, has failed to revive credit growth due to which banks are expanding their duration in bond portfolio. The other key factor contributing to the rally has been flows from foreign institutional investors (FIIs) in debt. 2014 has been a year when FII flows in debt has surpassed equity. FIIs have invested Rs 1.42-lakh-crore in debt compared with Rs 92,952 crore in equities.

Jaitley had said in a key-note address at the Citi’s Investor Summit here on Monday: “I am quite clear in my mind that the cost of capital has to come down. Inflation has moderated, global fuel price has eased. Therefore, if RBI, which is a highly professional organisation, in its wisdom decides to bring down the cost of capital (it) will give a good fillip to the Indian economy.” (Steepest declines in govt bond yields since 2008)

The yield on the 10-year benchmark bond ended at 8.15 per cent on Tuesday compared with the previous close of 8.18 per cent. The yield on the 10-year bond had ended at 8.14 per cent on August 8, 2013.

The yield on the 10-year bond, which ended at 9.10 per cent on April 7, has dropped sharply since the Bharatiya Janata Party won elections.

“The rally in the bond market is on expectations of a 25 basis points cut in the repo rate on December 2. The 10-year yields may fall close to 8.10 per cent and even touch 8.10 per cent in the run-up to the monetary policy. However, a fall below the 8.10 per cent mark will need an actual rate cut by RBI,” said Balginder Singh, a government bond dealer at Andhra Bank.

The repo rate, which has been kept at eight per cent since January 2014, might be cut to 7.75 per cent as early as December on the back of softening Consumer Price Index (CPI)-based inflation numbers. Retail inflation dropped to an all-time low since the country started computing CPI in January 2012. Retail inflation for the month of October dropped to 5.52 per cent, down from 6.46 per cent in the previous month. RBI has set a retail inflation target of eight per cent by January 2015 and six per cent by early 2016.

“The market is trying to guess whether the finance minister will be in a position to impress upon RBI to cut rates or not. I think the fall in yields are limited till the monetary policy,” said Ashutosh Khajuria, president (treasury) at Federal Bank.