Bond market sees best day in 2 months after S&P upgrades India's rating

S&P raises India's sovereign rating to BBB from BBB-, the first upgrade since 2007, citing fiscal discipline and infrastructure push, triggering a G-sec rally

Government bond prices surged on Thursday after global rating agency S&P upgraded India’s sovereign credit rating from BBB- to BBB, recognising the government’s commitment to fiscal discipline alo­­­n­g­side its strong infrastructure push. 

The yield on the benchmark 10-year government bond fell by up to 10 basis points (bps) during the day but gave up some gains towards the end due to profit booking. Bond prices and yields are inversely related. The rupee, which depreciated 0.14 per cent on Thursday to close at 87.56 against the dollar compared to 87.44 on Wednesday, trimmed some losses after the rating upgrade announcement. 

The benchmark yield fell to 6.38 per cent before settling at 6.40 per cent for the day, versus Wednesday’s closing of 6.48 per cent. This is the largest single-day drop in yields in two months.

 

“Now that the yield has fallen below the 6.40 per cent mark, we might see 6.35 per cent soon,” said a dealer at a primary dealership.

 

Government bond yields had been rising since the Reserve Bank of India’s (RBI’s) monetary policy committee meeting in the first week of August due to the policy’s slightly hawkish tone. Market participants had been expecting a dovish pause or even a hawkish rate cut. However, the committee kept the policy repo rate unchanged at 5.50 per cent and projected first-quarter inflation for the next financial year above the RBI’s 4 per cent target, thereby diminishing expectations of additional rate cut. 

 

Experts said Thursday’s bond market rally was driven mainly by positive sentiment, expectations of stronger foreign inflows, and recognition of India’s improved fiscal discipline, rather than hopes of lower government borrowing.

 

They said the government is expected to meet its 4.4 per cent fiscal deficit target, but weak direct tax collections (especially corporate tax) and only moderate cash surplus mean there is little scope to reduce borrowing or supply of government bonds. However, indirect tax collections like goods and services tax (GST) remain strong, and any fiscal support for exporters is likely to have limited cost, meaning a significant rise in borrowing is not expected.

 

“The reaction of the bond market reflects positive sentiment created by the rating upgrades, but it doesn’t reflect the fact that the market expects a cut in borrowing. That will depend on domestic dynamics like tax collection and how the government manages expenditure. Right now, we don't expect any extra borrowing. But at the same time, we don't see scope for them cutting G-sec supply," said Gaura Sen Gupta, chief economist at IDFC FIRST Bank.

 

Expectations of an increased government bond supply in the second half of this financial year on the back of a 50 per cent US tariff on export of Indian goods had hardened the yields for the past week. However, S&P said the tariff’s overall impact would be minimal and is unlikely to hinder India’s long-term growth prospects.

 

“The rating upgrade validates the country’s long-standing case for an upgrade and reinforces the India growth story,” said Madan Sabnavis, chief economist at Bank of Baroda.

 

“S&P has also noted that India will not be severely impacted by US tariffs. While the upgrade will not affect the Indian government’s borrowing costs, since it does not borrow overseas, corporates with high domestic ratings could see their cost of funds in international markets decline by 5-10 bps. The G-sec market’s reaction was a one-off, driven by S&P’s praise for the government’s fiscal consolidation efforts,” Sabnavis added.