After the government announced a surprise cut in corporate tax rates to revive the sagging economy, the bond market on Friday went into a tizzy with the prices falling and yields rising sharply, amid concerns over the possibility of higher borrowings and the government’s ability to balance its books and meet fiscal targets.
The yield on benchmark 10-year bond rose by 15 basis points (bps) to 6.79 per cent. Corporate bonds across the curve saw similar moves, with analysts now expecting only a smaller rate cut by the Reserve Bank in the October policy.
With the debt market expecting higher borrowing by the government this fiscal, the 10-year bond yield rose by 20 bps intra-day.
“We expect the 10-year yield to trade in the range of 6.7-6.9 per cent in the near term. Higher borrowing pressures and risks related to a spike in oil prices are likely to somewhat offset the impact of a rate cut by the RBI in October. Moreover, we now expect a smaller cut by the central bank given that a fiscal stimulus is likely to take some pressure off the RBI to support growth. We expect a 15-25 bps cut by the RBI in October,” said Abheek Barua, chief economist, HDFC Bank.
On Thursday, RBI Governor Shaktikanta Das hinted that there could be more reduction in the policy rate in the near future, in the wake of lower inflation and the deepening slowdown in the economy.
“There’s a room for more rate cuts especially when growth has slowed down,” he had said. However, there could be some support for yields as well. Given the increase in expected borrowings, the likelihood of a sovereign bond issuance has increased. An announcement on this front, could somewhat temper the pressure on yields, Barua said.
Analysts said policy action from the government and the RBI up until now has been in response to weak economic factors both on the global and domestic sides as well as weak consumer sentiment.
“The liquidity squeeze further exasperated this situation. Today’s announcement by the government is clearly counter-cyclical in nature and we believe this is a long term positive for the Indian economy,” said R Sivakumar, head of fixed income, Axis Mutual Fund. He said the bond market sell-off today is a knee-jerk reaction to the implications of revenue loss arising out of tax reductions. Market participants will now look to the upcoming monetary policy on how the government and the RBI manage the national balance-sheet.
“On the rates front, the jump in yields on the benchmark 10-year bond to an intra-day high of 6.876 is still materially lower than the 8 per cent levels we saw in September 2018. Actively managed short-term AAA strategies currently offer attractive investment opportunities as spreads continue to remain elevated. One-to-three year corporate bonds continue to trade at 200 plus basis points above operative rates,” Sivakumar said.
Meanwhile, the rupee gained by 40 paise to close at 70.94 against the dollar, following the rally in equity markets. Traders expect a rise in capital outflows and a pick-up in investments and growth in the economy to strengthen the currency.
While higher equity and foreign direct investment (FDI) flows driven by Friday’s announcement are likely to be positive for the rupee, concerns over the fiscal situation and risks related to oil could put a floor to the USD/rupee pair, said an analyst.