Indian bonds best performers in Asia in 2016: Nomura

The year gone by turned out to be very profitable for Indian bonds which emerged as the best performers in Asia in 2016, says a Nomura report.

According to the Japanese financial services major, Indian bonds outperformed sovereign bonds in the rest of the region (Hong Kong, China, Taiwan, Thailand, Malaysia, Korea Singapore, Indonesia) last year and the yield curve is likely to steepen further this year.

"In 2017, we expect yield curves to have a steepening tendency and thus suggest investors to take a buy-on-dip approach in front-end bonds," Nomura said in a research note.

According to the report, three key events shaped rates market dynamics in 2016, first, RBI conducting OMO purchases that supported bond demand.

Moreover, the Brexit vote and Raghuram Rajan's departure from the Reserve Bank of India led the market to increase its rate-cutting expectations which in turn led to lower rates.

The recent demonetisation effort led to improved liquidity in the banking system and again fed into bond demand.

Going ahead Nomura sees a confluence of factors - a lack of OMO purchases, end of easing cycle dynamics, large state bond supply, the US Fed hiking cycle and a potential pick-up in credit growth - can steepen the yield curve in India, and "we expect this to become visible in 2017," Nomura said.

As of January 6, India had currency in circulation of around Rs 8.98 trillion, which is around half of the Rs 17.97 trillion of currency in circulation on November 4 (before demonetisation).

"Thus 50 per cent of the currency in circulation (Rs 8.99 trillion) is now in the banking system, which results in surplus liquidity conditions," it added.

Another factor that is likely to steepen the yield curve is the end of easing cycle dynamics, after 175 bps of rate cuts, this easing cycle appears to be nearing its end.

Nomura said its India economist Sonal Varma expects only one more rate cut in this cycle.