Bonds sell-off despite rate cut as fiscal deficit, GST shortfall weigh

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October 5, 2019 2:54 AM

Experts believe that for any further rate cuts, the central bank will have to revise the growth projection further downwards, which may be a bit difficult considering there was a sharp downward revision in growth estimates in the current policy.

Bonds sell off, fiscal deficit, rate cut,  GST shortfall, Reserve Bank of India, inflationOne thing that the bond market may be looking forward to is the announcement of open market operations (OMO) purchases by the central bank during the festive season when the system liquidity is expected to reduce.

Bonds sold-off on Friday with the benchmark yield closing 8 basis points up at 6.69%, despite the Reserve Bank of India (RBI) cutting the repo rate by 25 basis points and indicating that it will continue with its accommodative stance as long as it was necessary to revive growth, while ensuring inflation remains within the target.

Meanwhile, the cut-off on the new ten-year benchmark bonds that were auctioned on Friday came in at 6.45% with the yield on the bonds closing the day’s session at 6.46%. Manish Wadhawan, independent fixed income and forex expert, believes the rate cut was on expected lines in view of the growth projections being lowered and inflation expectations in the economy. “However, bonds may not see any rally in the near-term as concerns over fiscal deficit and GST collection shortfall still loom large. Even foreign portfolio investors do not seem to be too positive on Indian debt. The new ten-year benchmark yield should settle around 6.50% in the near term,” he said.

Experts believe that for any further rate cuts, the central bank will have to revise the growth projection further downwards, which may be a bit difficult considering there was a sharp downward revision in growth estimates in the current policy.

MS Gopikrishnan, independent market expert, said fiscal deficit is definitely a matter of worry, which the RBI is not openly acknowledging. “I think the RBI will keep a watch on the fiscal deficit. The central bank’s revised growth estimate of 6.1% is below most analysts’ expectation. To go further below this, there needs to be more bad news coming. In my view, they won’t have too many reasons to cut rates going forward,” he said.

One thing that the bond market may be looking forward to is the announcement of open market operations (OMO) purchases by the central bank during the festive season when the system liquidity is expected to reduce. The question, however, is not whether the RBI will do the OMO purchases; rather, it will be the quantum of OMOs that the central bank may announce. Some experts feel the OMOs at the end of the year will not be sufficient to allay the excess supply of bonds available in the market.

“System durable liquidity seems to be surplus in the near term and there is no opportunity for conducting open market operations (OMO) purchases. Even when it happens the size could be low, which will not be enough to suck the excess supply of bonds in the market,” Gopikrishnan said.

However, a section of the market is of the view that there could be reasonable OMOs during the end of the year.
Vijay Sharma, senior executive vice-president at PNB Gilts said although the action and the language from the central bank were positive for the bond market, there was a sell-off as a section of the market felt the rate cut could be to the tune of 40 basis points.

“Yes, there are concerns on the fiscal deficit front and that is the only thing keeping the yields at elevated level. On the liquidity side, at the first instance of any tightening, the RBI will conduct OMOs and we feel Rs 75,000-1,00,000 crore of OMOs could find their way into the system from mid-November to mid-February,” Sharma said.

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