2018: Bond yields to stay elevated; rupee stable

The yield on 10-year government bond rose to a 21-month high of 7.40 per cent on Thursday before closing the year at 7.32 per cent. Bond dealers say, by the time of Budget announcement, they could march up to 7.80 per cent levels. That would be a sharp rise, considering that in early August yields were below 6.50 per cent. What’s ironic is that yields have been rising even after a rate cut in August as the market doesn’t see any scope of rates softening on the face of hardening inflation.
 
The new year would be interesting for bond market. Even as supply of fixed income papers would remain elevated, the appetite for those would be waning. Foreign portfolio investors have bought Rs 1.4 lakh crore of Indian debt in 2017. But, that cushion will not be available in 2018 as the existing limits have been filed up and only marginal increase in limits is likely for foreign investors. Therefore, the entire load would have to be carried by the domestic investors, who are not interested currently.
 
Here, one needs to see if India would be fine in increasing the foreign investment limit further. That will have a huge ramification for the bond market and everybody will cheer.
 
“But, that is a mind-set issue. The government will have to take a call if they would want more foreign holding of domestic papers or not,” said Harihar Krishnamurthy, head of treasury at First Rand Bank.
 

But, Krishnamurthy expects the rupee to remain stable as the equity market would continue to attract foreign investors. Of course, there would be some gradual fall  in the rupee, in line with the Reserve Bank of India’s agenda of preserving India’s export competitiveness.
 
Currency dealers expect the rupee to remain in the 64-66 a dollar range for most part of 2018, save heightened economic and geopolitical uncertainties that would lead to outflow from emerging markets.
 
In absence of any steps taken to further open up the debt segment to foreign investors, the bond market would struggle for the first few months of 2018. In between, Budget would map much of the course for yields, but starting second half, yields should start letting out some of the pressures as base effect kicks in on inflation, said Jayesh Mehta, head of treasury at Bank of America Merrill Lynch.
 
If there is no untoward spike in geo-political tension, oil prices would likely remain within $70 a barrel level, something that India can manage. However, global interest rates are firming up and domestic bond yields can hardly remain immune to that.
 
Next year will also see recapitalisation bonds by the government, which would satiate some demand from banks even as states are expected to be profligate in their spending.
 
Many analysts expect their borrowings to equal centre’s in a year or two. And, yields will start reflecting those much in advance and so, 2018 may not be a good year for bond market.