India's bond rally could stall as investors worry about govt's fiscal math

India’s bond rally is predicted to stall as investors turn jittery about the government’s fiscal discipline before next month’s federal budget.

The 10-year yield will stay close to current levels at 6.98% by end of June, according to a Bloomberg survey, bringing an end to the slide of about 50 basis points over the past six weeks. Yields have tumbled as the Reserve Bank of India cut interest rates, Prime Minister Narendra Modi won a thumping election victory and slowing global growth spurred a global debt rally.

Bond traders have already shown signs they can be nervous about the nation’s financial health. Yields jumped the most in eight months on Feb. 1 when the government announced plans to borrow a record 7.1 trillion rupees ($101.8 billion) in its interim budget. With economic growth and tax collections worsening, markets are worried the administration may need to seek more funding to finance a wider budget deficit.

“Incremental economic data after February hasn’t been favorable and we’re keen to see whether the borrowing number is revised upwards” in July’s budget, said Badrish Kulhalli, head of fixed income at HDFC Life Insurance Co. in Mumbai. “The key concern for the market will be the budget and the fiscal deficit number.”

Market watchers are also scrutinizing technical indicators that are signaling bonds may have become too expensive after their six-week rally.

“We remain cognizant of the technical signals suggesting over-bought market conditions and potential pull back in yields,” said Dhawal Dalal, chief investment officer for fixed income at Edelweiss Asset Management Ltd. in Mumbai. “A higher-than-expected supply of bonds amid declining tax revenue projections and sticky fiscal deficit may result in further steepening of the yield curve.”

Once bond markets have digested July’s budget, there may be room for the rally to resume. Ten-year yields are poised to drop to 6.78% by the end of September, according to the Bloomberg survey of 10 traders and analysts. The yield rose two basis points on Monday to 6.94%, snapping a four-day gaining streak.

Here are more comments from money managers and economists:

ING Group NV (Prakash Sakpal, economist)

• “I see greater risk of an upward move in the yield, than downward”
• Key drivers will be a potential rise in “inflation, slowly but surely, and a sustained supply overhang from a large fiscal-deficit funding requirement”
• “While central banks elsewhere, especially those in the developed markets, are just venturing into policy easing, I believe the RBI’s easing cycle is over. I expect all these factors re-asserting themselves in pressuring bond yields higher”

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

• RBI’s stance “bodes well for bonds. Against this however, fiscal risks still linger and the market will have to contend with the associated higher supply”
• “The outlook is constructive given a global dovish policy pivot against a backdrop of slowing growth”
   

AU Small Finance Bank (Debendra Dash, head of fixed income)
 

• “Most factors are positive for the bond market but there can be a lot of volatility on account of fiscal risks or a potential increase in oil prices. These are unforeseen events which can come in the way” of a rally