The yield on the 10-year benchmark bonds closed at 6.32% on Tuesday, nearly 50 basis points lower than their close on November 8, the day demonetisation had been announced. This is the lowest closing level for the 10-year benchmark yield since May 2009.
Gilts with shorter tenures have also seen decline in yields – the 5-year gilt yield was at 6.29% on Tuesday, 41 bps lower than its November 8 closing, while the yield for 3-year gilt stood at 6.15%, 42 bps lower than November 8 close.
Market participants now see the 10-year benchmark yield heading to levels as low as 6%. “Yields are likely to fall further to around 6.00%-6.10%, supported by lower inflation. The earlier expectations of a 25-bps cut by end of this fiscal year have now changed to expectations of a 50-75-bps cut over the same period,” Ajay Manglunia, head of fixed income at Edelweiss Securities, said.
Ganti Murthy, head of fixed income at IDBI Mutual Fund, said if chances of a rate cut in December were 50:50 before demonetisation, it is now at least 75:25 in favour of a rate cut. “Around Rs 5 lakh crore of deposits have come into banks and let us assume this is approximately Rs 8 lakh crore by December 6. That is Rs 8 lakh crore of money that has to be pumped back into the system.”
R Sivakumar, head of fixed income at Axis Asset Management Co, believes the fiscal balance would be better this year, either owing to higher tax collections or if the money is deposited, as RBI profit. “That is what the market is factoring in right now,” Sivakumar said, adding demonetisation has impacted overall economic activity, which, in turn, would adversely impact both inflation and growth.
Manglunia said it would take a while for enough currency notes to be back in circulation, perhaps March 2017. “Until then, banks will continue to have a high deposit base and will continue to buy government bonds,” he said.
Even the 2-year and 1-year gilt yields have declined by as much as 42 bps and 35 bps, respectively, over the period under review to close at 6.13% and 6.18% on Tuesday.
Given the prevalent dearth of supply of higher-denomination currency notes in the economy, individual consumption is expected to go down, driven by a fall in demand for most goods. This will most likely to result in a lower consumer inflation number, which could push the central bank to cut interest rates aggressively.
Typically, the market factors in any development three-six months prior to the development actually taking place. Considering there are two more policy meets scheduled to take place between now and the end of the fiscal year, the market might factor in 50-75-bps rate cuts in the immediate term.
Murthy said although the impact of demonetisation on inflation in near term is expected to be adverse, it is left to be seen what kind of impact it will have once things settle down.
The dearth of cash has resulted in low demand for crops planted in the current sowing season, discouraging farmers from sowing any more. Consequentially, prices of the existing stock are likely to fall in near term.