Gilt yields drop 29 bps on govt's lower borrowing target for H1FY19

Relief to banks as pressure from MTM valuation will subside for 2017-18

The yield on 10-year gilt crashed 29 basis points on Tuesday after the government’s announced a lower borrowing target for the first half of 2018-19.

The softening of yields is expected to bring relief to banks as chances of booking losses on bond holdings have declined in the fourth quarter ending March. Banks have to make mark-to-market provisions for erosion in bond values. According to bond dealers and treasury executives, yields in the market softened by over 25 basis points, reflecting an immediate impact on investor sentiment. Equilibrium would be reached at a higher level, but was likely to remain below the 7.62 per cent 10-year benchmark rate (7.17 per cent for bonds maturing in 2028) on Monday, said Madan Sabnavis, chief economist, CARE Ratings.

Yields were down in opening trades on the 10-year gilt at 7.44 per cent from the closing levels of 7.33 per cent on Monday, according to data from the Clearing Corporation of India. The government on Monday reduced its overall borrowing target for April-September 2018-19 and lowered the share of longer tenure gilts.

Lower borrowing in the first half and shorter tenures would provide some respite, DBS Bank said in a note. The relief comes after a combination of weak macro-economic numbers, adverse demand-supply dynamics and higher US rates pushed 10-year gilt yields from 6.5 per cent in August 2017 to 7.7 per cent earlier this month. 

Dealers said while the market would see a spell of low yields in the first half, there was a risk of reversal in the second half (October-March) due to higher government borrowings.
 
Kotak Securities in its report said possible risks might emerge in the second half of 2018-19, which could exert pressure on bond yields. First, the higher-than-usual borrowing in the second half, which is normally the busy credit season. Second, a possible shortfall in the National Small Savings Fund. Finally, a risk of fiscal slippage if goods and services tax revenues remain weak in the first half of 2018-19, implying the risk of higher borrowings.
 
Increasing reliance on government borrowings in the second half of the next fiscal year, coupled with an improvement in private spending could result in a crowding-out effect, thereby implying the hardening of gilt yields in the latter half of 2018-19, said Dhananjay Sinha, head of research and economist at Emkay Global Financial Services.
 
The cooling off in gilts is likely to have a two-fold impact on banks. First, the likelihood of treasury losses during the fourth quarter of the current financial year will decline significantly and second, the expectations of upward pressure in deposit and lending rates will ease. Interest rates on the government’s small savings schemes are linked to 10-year gilt yields. With an increase in yields during the fourth quarter, there is a possibility of these rates rising as well.
 
Easing of the upward pressure on bank lending rates and softening of corporate bond yields augured well for corporate profitability and their debt servicing ability, said Karthik Srinivasan, group head, financial sector ratings, ICRA.