Nervous Bond St eyes MPC meet

The high government borrowings and the lack of demand in the market to support it is expected to push up yields on the government bonds further.

The US Treasury yields were down by 14 basis points, which pushed down yields on the government bond by 8 bps on Tuesday morning, but they rose again ahead of the Reserve Bank of India (RBI) policy on Wednesday, but finally closed lower. The issue is about an oversupply of government bonds and a lack of demand, which is expected to keep the yields high. Now everything hinges on what RBI says in the policy on inflation and liquidity in the market.

Treasury experts say the foreign portfolio investors (FPI) limits may be hiked and open market operations (OMOs) may be announced so that the government borrowing can pass through without sending jitters in the government bond market. On the demand side, banks are already holding more bonds than required for maintaining their Statutory Liquidity Ratio (SLR), while foreign portfolio investors (FPIs) are holding the maximum amount of government bonds.

"Both parties have suffered mark-to-market losses in their investment portfolios from the recent bond market volatility. The ten-year yields are up by 24 basis points from the start of the year," DBS Bank said in a report. But on Tuesday the yields ended lower. The new year government bond ended at 7.57% lower than yesterday's level of 7.60% while the old ten year benchmark bond ended at 7.75% lower than yesterday's close of 7.78%.

Vijay Sharma, senior executive vice-president, PNB Gilts, said, "The yields will keep on rising until there is mismatch between the supply of government bonds in the market and the demand for it. Much will depend on RBI policy the announcement of OMOs and hike in the foreign portfolio investors limits and its take on the inflation."

However, some experts say the rise in bond yields is overdone and that there could be a rally.

Ashutosh Khajuria, executive director, Federal Bank, told DNA Money, "The difference in the repo rate (6%) and the 10-year bench mark government bond is on an average about 180 bps which is unnatural. Even during 2013 when the yields had risen sharply the difference was just 150 basis points, so there is bound to be a correction in the market."

The bond market's nervousness over the impending demand-supply imbalance is understandable. The supply pipeline will be busy under the FY19 borrowings plan; gross market borrowings are set to rise to Rs 6.1 lakh crore from Rs 5.8 lakh crore in FY18 (excluding T-bills). Banks' credit growth has picked up amidst slow deposit growth, providing banks with little incentive to lock up funds by increasing bond purchases.

Radhika Rao, economist with DBS Bank, said in the report, "Budget fiscal 2019 triggered a sell-off in the Indian bond markets last week. The yields on the ten-year government bonds rose 20-30 bps to more than 7.60%; it was flat mostly around 7.20-7.40% for most of January. Optimistic revenue projections and concerns over the inflationary impact of budgetary measures weighed on sentiment. Higher fiscal targets for fiscal 2019, along with rising oil prices, are set to make RBI policy path a tricky one this year."