Informist, Friday, Jun 7, 2024
By Aaryan Khanna
MUMBAI – The government bond market was already poised for a good run in the coming weeks. Traders continued building their portfolios today, unperturbed by the monetary policy outcome, as none of the comments were seen halting the price momentum in gilts.
The Monetary Policy Committee today kept the policy repo rate unchanged at 6.50% and also maintained the stance at "withdrawal of accommodation", exactly as expected. In the market's perception, Reserve Bank of India Governor Shaktikanta Das also stuck exactly to the script he had laid out in the February and April monetary policy reviews.
"The tone of the governor and the policy statement continued to be pretty standard, noting two-way risks to inflation while nudging current financial year growth expectation up a shade," said Suyash Choudhary, head – fixed income at Bandhan Asset Management Co. "We had recently analysed our structural view on Indian bonds and concluded that it remains very much intact post-election, with further evidence likely to be provided by the July Union Budget."
Bond prices are expected to run up from two major developments. The first, and more structural, is India's inclusion on JP Morgan's Government Bond Index – Emerging Markets starting Jun 28. The index inclusion is expected to fetch about $25 bln in foreign purchases of gilts. Consistently, foreign portfolio investors have been piling onto gilts maturing after 2026, particularly with passive fund trackers also entering the market as the date of inclusion nears. FPIs have bought over 800 bln rupees of index-eligible gilts since JP Morgan announced the inclusion, with 61.81 bln rupees coming in the first week of June alone.
The second is the government's pent-up spending owing to the Model Code of Conduct in the run-up to, and during, the six-week-long General Elections. Adding to this cash pile is the RBI's record 2.11-trln-rupee surplus transfer declared in May, which the new government is likely to spend as it settles in during June and presents the Union Budget for 2024-25 (Apr-Mar) in July, dealers said.
Rate cuts have remained out of the realm of immediate possibility for the bond market, and there were no such hopes for the MPC to meet in June either. Currently, government bonds and overnight indexed swap rates factor in rate cuts earliest in Jan-Mar, with traders offering a December rate cut view only if growth disappoints significantly. With RBI raising its projected GDP growth projections for 2024-25 by 20 basis points to 7.2%, even traders with boiling hopes have simmered down.
During the recent monetary policy reviews, the RBI has had a tendency to readjust its goalposts on inflation, or tighten the policy belt a notch. Traders complain that this has coincided with times that bonds have been on the cusp of significant gains, in a bid by the regulator to signal its discomfort with borrowing costs in the economy coming down and stoking consumption.
Das said multiple times today that the last mile of disinflation was going to be arduous, and inflation remained sticky above the RBI's target of 4%. The central bank kept its projects for headline consumer inflation unchanged at 4.5% for 2024-25. The governor also called Jul-Sep projection, a decline to below the RBI's 4% CPI target, a "one-off". Though the refrains were tough, their familiarity felt soft on traders' ears.
The index inclusion and government spending are expected to create a deluge of liquidity that reaches banks by July, boosting their demand for short-term bonds especially. Despite multiple questions at the post-policy presser on what tools the RBI would introduce to sterilise these inflows, Governor Das refused to specify any fresh measures. With no mention of the dreaded open market sale operation, that the RBI had suggested as a liquidity absorption tool in October, bond traders cheered. Bond yields are seen likely to fall, following overnight money market rates easing.
Another encouragement was the voting pattern at the MPC. External member Ashima Goyal added her support to sole dissenter Jayanth Varma on the stasis in monetary policy over the last year. On both rates and stance, the six-member committee voted 4-2, against 5-1 in April. In addition to inflation being in line with the RBI's projections over the last few months, this suggested that slow as it may be, things were going according to plan on the rate front.
"While it does not mean that we expect a rate cut in the next policy meeting, it shows that the RBI is gradually moving towards a rate cut regime," sai Sandeep Yadav, head of fixed income at DSP Mutual Fund. "...from today's statement, we believe that the future course of liquidity management will change, and the RBI may keep the overnight rate at repo rate."
SHORT-TERM WINS
India's sovereign bond yield curve has been "flat", and even slightly inverted, over the last few months. This means the most-traded bonds maturing in 2-7 years have all provided higher returns to investors than the 10-year benchmark gilt. With what is seen as a free run to liquidity in the near-term, short-term bonds have gained sharply over the last two days.
The five-year benchmark 7.37%, 2028 gilt ended 2 basis points lower at 7.02% today. The yield on the 10-year benchmark 7.10%, 2034 gilt, offered at the bond auction today, ended marginally higher at 7.02% as well. Bonds maturing under five years are also preferred by foreign portfolio investors, key as their activity increases due to India's inclusion on global bond indices. Now, short-term yields are expected to fall more than the 10-year benchmark, which may remain in a 6.95-7.15?nd, dealers said.
"We do have a better view of liquidity following the policy, which is lending some legs to the short-end of the curve," said Rajeev Radhakrishnan, chief investment officer – fixed income at SBI Funds Management Ltd. "I think it's premature to even think about rate cuts right now, but easy liquidity could culminate in a stance change by October if all data goes according to plan." He expects the yield curve to steepen gradually.
For long-term bonds, an additional risk comes from the policy plans of the incoming government. Additional expenditure would boost liquidity and appetite for short-term gilts, but could result in added gilt issuance, which has been heavily concentrated in bonds maturing above 10 years. At the same time, passive investors tracking bond indices have preferred these gilts, with their much higher individual weightage than short-term bonds due to the higher outstanding.
In their rate cut view, traders remain much more sanguine than analysts, having been on the wrong side of trade more than once over the past year. HSBC sees an August rate cut as its base case. Economists, including those at Standard Chartered and State Bank of India, see the MPC cutting rates in October. At that time, another risk emerges: the three current external members of the MPC are scheduled to be replaced with fresh ones by the government in September.
"Unless global data surprises otherwise, two external members are likely to vote for a cut and change in stance in next policy as well," said ICICI Bank in a note, giving voice to calls by its traders. "By then other members would also know the monsoon and fiscal trajectory. This makes a case for change in stance to be considered even in (the) next policy." End
US$1 = 83.34 rupees
(With inputs from Nishat Anjum)
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