RBI policy review today to set tone for bond yields

Yields on government bonds continued to rise on worries about fiscal deficit and that the US tax reforms will usher in lower tax rates and, in turn, push up US treasury yields and consumer price index (CPI) inflation.

The trend will continue for a while, say market experts, unless if the Reserve Bank of India (RBI) cuts the repo rate in its policy today.

Jayesh Mehta, managing director and country treasurer, Bank of America, said it is highly unlikely that RBI would cut the rates with so many uncertainties.

"The US tax reform, inflation, the fiscal deficit and the supply demand dynamics are all weighing down on the market. The global situation is also not encouraging for the market to draw some comfort. Yields will continue to harden for a while," he said.

However, the government put out a note on Tuesday, saying the rollover risk of the its debt in the next five years is negligible with the debt that has to be repaid just being 5.3% of its outstanding stock. It said that the risk of rollover can be mitigated by replacing shorter-term debt with longer-term bonds.

But the market is unlikely to be relieved by the government note. Treasury head of a bank said, "This will still impact the supply demand dynamics as it is happening now. The market will continue to worry about the additional borrowing that the government may have to undertake."

The yields on the government bonds rose to 7.10%, though some losses were shaved off on Tuesday, but it traded a narrow range of 7. 8% to end at 7.5%.

Vijay Sharma, executive vice president for fixed income at PNG Gilts, said, "The worry for the market is the high crude oil prices, higher fiscal deficit and an anticipation of higher government borrowing is worrying the market."

So far in the calendar year, RBI absorbed Rs 90,000 crore of government bonds from banks while trying to neutralise the liquidity in the market. Last month, it called off an Open Market Operation (OMO) signifying that the central bank was not comfortable with a yield beyond 7%.

Banks' holding of the government debt as of end-March eased to 40.5% of outstanding stock from 41.8% a year ago while insurers increased their holdings to 22.9% from 22.2% in March 2016. The central bank's holding of sovereign debt also rose to 14.7% of the total stock as of March 2017 from 13.5%, according to the data compiled by Reuters.

A bond dealer with a private sector bank said, "The higher crude prices and an expectation that the government would borrow higher is leading to hardening of yields. Even on the bank recaptilisation, there are still no details on the modalities which is creating a confusion in the market."

"Foreign banks are front-running the market leading to yields to rise further. The US tax cut reforms will also have some concomitant impact in India," he said.

Some bond dealers felt that there is room for a rate cut as the the yields have risen with the difference between the repo rate, which is at 6%, and the government yields at 1.10%. The ideal difference in yields between the ten-year benchmark bond and the repo rate should only be 0.75% to 0.85%.

India Forex Advisors said in a report, "Rupee jumped to an 11-week high as foreign banks sold the greenback, whose rally stalled as investors paused to see how the two chambers of the US Congress reconcile their respective versions of the tax bill." The rupee ended the day at 64.38 to the dollar. It had risen to a three-month high at Rs 64.21 to the dollar but retreated sharply.