By: Sandesh Kirkire
Government securities or gilts have rallied at various stages over the last six months. The main factor behind this is the fall in yields of the long-term gilts, principally the 10-year Gsec that has seen yields decline from 8.81 per cent-levels in January and April to the current levels of 8.54 per cent. This is a rally of around 30-35 basis points within a span of three months.
The rally has been driven by a reversal in the negative sentiment among investors caused by a stable government at the Centre. The limiting of the fiscal deficit for FY15 to 4.1 per cent of the GDP as announced in Budget 2014-15 have given markets a reason to cheer. Also, the high-base effect, better supply management and pick-up in the monsoon, dissipated fears of a food supply-driven inflation. Thus, while inflation measured by the Consumer Price Index (CPI) stands at 7.96 per cent in July 2014, higher than the June figure, the larger inflation trajectory remains downward. In fact, the market expects the inflation to moderate faster in the coming months and reach well below the 8 per cent-mark by January 2015 as targeted by the RBI. Expectation of a better investment climate may see improvement in manufacturing levels; and help improve aggregate supply.
At the market level, the appetite from foreign institutional investors (FIIs) for Indian GSecs remains strong, with nearly $14 billion of net purchases in 2014. While this demand remains susceptible to exchange rate fluctuations, the RBI looks intent on smoothening foreign exchange volatility and is therefore mitigating the currency risk to some extent. Moreover, since the quantum of GSec supply in FY15 is largely similar to that of FY14 levels, we perceive that even at natural progression of M3 (a measure of money supply) and bank deposit growth, the appetite for debt must rise.
However, the downside risk to market sentiment remains — mainly from the unforeseen events from the agriculture sector, the energy sector or from exchange rate volatility. Thus, while the food supply risk now seems to be declining, there is a high latent geo-political risk especially from events in the West Mediterranean (Gaza issues), in the Euphrates region (Iraq-Syria), in the North Black Sea (Ukraine) and even in the South and East China Seas as they pose a risk of a quick escalation. The unpredictable events in these regions can cast a long shadow on oil prices and exchange rates, thus impacting the debt market.
Having said that, the market sentiment is largely optimistic and perceives a gradual moderation in the policy stance, as well as in the interest rates. The liquidity conditions too are expected to ameliorate as the CPI inflation reaches a more tolerable threshold.