Lower govt borrowing saves the day

But expectations of softening of interest rates are low on hawkish inflation, liquidity stance

The bond market threatened to test the lows on budget day as oil prices trended higher on a weakening dollar, with Nymex crude futures trading over $102/bbl and inflation for the week-ended February 16 higher than expected with the wholesale price index (WPI) growth coming in at 4.89% against the market expectations of 4.70%.

The government announced a slew of spending measures in the budget. The 10-year yields rose by 5bps from lows on fears of higher government bond supply.
The fears proved unfounded with the government surprising the market with lower-than-expected borrowing figures for 2008-09.

The budget estimates that the government will raise Rs 1,45,000 crore by selling government bonds, while the market was expecting a gross borrowing of around Rs 1,70,000 crore.

Net of redemptions, the borrowing will amount to Rs 1,00,000 crore, which is lower than the market expectations of Rs 1,15,000- 1,20,000 crore. The positive surprise saw bond yields rally with the 10-year benchmark bond seeing yields fall by 10bps after the borrowing announcement.

However, the hawkish stance of the government on inflation and liquidity flows saw the market selling at higher levels and the 10-year bond closed up 2bps from lows in yield terms. 

The lower borrowing of the government is largely due to the surplus, which the government is carrying into next year. The surplus is estimated around Rs 40,000 crore. However, there are questions on how the government will fund the agricultural loan write-offs of Rs 60,000 crore and the pay panel recommendations.

The market will look at liquidity conditions, oil and commodity prices and global markets for direction.

Liquidity is expected to be tight around mid-March as advance tax goes out of the system. The estimates are upwards of over Rs 35,000 crore. The Reserve Bank of India (RBI) has said that they will be proactive in liquidity management.

Oil prices are trading at over $100/bbl and are a threat to growth and inflation. US treasury yields fell sharply as the Federal Reserve is widely expected to cut rates on a steadily weakening economy, even though inflation numbers have been strong.
The 10-year US yields fell 27 bps week-on-week on weak economic data.

Liquidity, as measured by bids for reverse repo/repo in the liquidity adjustment facility (LAF) of the RBI, saw easing with bids for repo at 7.75% averaging Rs 10,889 crore against Rs 17,229 crore seen in the week before last. Overnight rates trended lower and came off from the 7.5% levels towards the end of the week.

Government bonds
Government bonds saw yields fall week-on-week. The yield on the benchmark 10-year bond — the 7.99%, 2017 bond — was lower by 12bps to close at the 7.57% levels. The 5-year benchmark bond yields were lower by 7bps, with the yield on the 7.27%, 2013 bond closing at the 7.57% levels.

Yields on the long bond — the 8.33%, 2036 bond — closed lower by 2bps at the 7.97% levels.  The 10-over-30 spread closed higher by 10bps at the 40bps levels. The lower-than-expected borrowing figures of the government for FY 2008-09 is positive for yields, though expectations of softening of interest rates are low on hawkish inflation and liquidity stance of the government.

Treasury bills, corporate bonds and overnight index swaps
Yields on treasury bills (T-bills) were higher last week. The cut-off on the 91-day, T-bill auction held on February 27 came in at 7.44% against a cut-off of 7.39% seen in the previous auction.

The 364-day T-bill auction saw the cut-off coming in at 7.55%, against a cut-off of 7.48% in the previous auction. The RBI is auctioning 91-day and 182-day T-bills worth Rs 500 crore each this week.

Corporate bonds saw yields sticky at the short end of the curve while yields moved down at the longer end on improved interest-rate sentiments.
One year papers were traded flat at 9.80% to 10% levels while five-year bonds were dealt at the 9.25% levels down, almost 10bps week-on-week.

The five-year AAA bond spreads were lower by around 5bps week-on-week at the 156 bps levels. Spreads are likely to remain under pressure on tight liquidity.
OIS saw the swap curve move down as interest rates fell and liquidity improved.  One- year OIS yields moved down by 10bps to close last week at the 7.08% levels while the five-year OIS yields closed lower by 11bps at the 6.87% levels.

The 1-over-5 spread remained inverted at the 21bps levels. OIS yields are expected to move in tandem with government bond yields. 

The author is head, portfolio management services, Sundaram BNP Paribas AMC Ltd. The views expressed by the author are his own and need not represent the views of the organisation in which he works.