Fiscal risks: Bond yield rises 24 bps since August repo cut

Fears of a possible slippage in the fiscal deficit with the announcement of stimulus package by the government has been haunting the bond market which has refused to transmit the reduction in the repo rate, say experts.

The 10-year benchmark yield has risen 24 basis points since the last monetary policy in August when the Reserve Bank of India (RBI) cut the repo rate by an unexpected 35 bps. Fears of a possible slippage in the fiscal deficit with the announcement of stimulus package by the government has been haunting the bond market which has refused to transmit the reduction in the repo rate, say experts.

Ananth Narayan, professor-finance at SPJIMR, points out that there is a question mark as to the true extent of the fiscal deficit and, therefore, to the extent of borrowing that the government has to conduct, either directly or through public sector enterprises. “There was a spike in the bond yields after the corporate tax rates were cut. That emphasises the trust deficit around the true fiscal deficit. While the government borrowing programme has remained unchanged, there is a fear that the borrowing by the state governments, FCI, NHAI and a whole host of quasi-sovereign entities and PSUs may keep the pressure on longer-end bond yields,” he says.

A series of bad news started impacting the bond market beginning September. First, there was an attack on the Aramco facility in Saudi Arabia that spiked oil prices, which pushed the yields higher. Then, in mid-September, the Centre announced a cut in the corporate tax rate, among other measures, to boost the economy — a news that was cheered by the equity markets but caused a sell-off in the bond markets.

MS Gopikrishnan, independent market expert, believes there were concerns on the fiscal deficit slippage even before the tax cuts and this was exacerbated by the shortfall in GST collections. “Finally, when the corporate tax announcements came, there was a lack of clarity on how the government plans to manage the revenue gap. The big question is whether additional supply will hit the market or not. Even if the repo rate is cut, bond yields may not fall too much unless the RBI packs the policy with some more action, like OMOs, among others,” he said.

Experts believe that to a small extent, the arrival of the new benchmark 10-year bonds also caused a minor sell-off in the current benchmark bonds. This is because whenever a new benchmark bond is issued, all market participants try to get a piece of the newly issued paper. This leads to some consolidation and, hence, a sell-off in the current benchmark bonds. The new benchmark bonds are currently trading at close to 6.40% in the “When Issued” market.

Arvind Chari, head, fixed income and alternatives, Quantum Advisors, points out that the RBI needs to keep the bond market anticipating for more to come for investors to remain interested in buying medium to long tenor bonds at the current levels. “Repo rate below 6% and bond yields below 6.5% are not regular occurrences and the markets have got scared on being too enthusiastic at these levels in the past. So more than the action, it is the communication that will be key and, to be honest, the RBI hasn’t done a good job of it over the last 3 years,” he said.