Slowdown impact: Bond yields stable despite higher Oct CPI inflation

Experts say the lower growth projections are helping boost expectations of a further rate cut and that is keeping the bond yields grounded.

The benchmark yield closed one basis point lower on Thursday to trade at a one-week low of 6.52% despite a higher consumer price index (CPI) inflation getting reported for the month of October, as expectations of a rate cut gained prominence among market participants with worsening growth projections.

On Thursday, October CPI inflation came in at a 16-month high of 4.62% compared to 3.99% in September. Under ideal circumstances, bond market reacts negatively to higher CPI inflation. However, Thursday’s lack of negative reaction indicates the market is anticipating further monetary easing in the December policy which is keeping the yields from rising.

Manish Wadhawan, independent fixed income and forex expert, believes the bond market is overlooking the higher CPI number while giving more credence to weak economic data.

“GDP data for the last quarter is expected to be quite weak in view of the IIP numbers recently released. It’s a balancing act between weak economic data and higher nominal CPI. Markets expect further monetary easing in the upcoming policy. There are also apprehensions on the fiscal deficit target being met this year. Going by the latest revenue data, the fiscal deficit might overshoot at least 50-60 basis points this year and the impact of this may start to reflect in the yields beginning January,” he said.

India’s fiscal deficit target for fiscal year 2020 (FY20) stands at 3.3%. For the first half of FY20, the fiscal deficit stood at 92.6% of budgeted estimates. A key thing to note is the muted tax collections that stood at Rs. 6.07 lakh crore in the first half of FY20—reaching only 37% of the budgeted estimates.

The central government’s gross market borrowing stood at Rs. 4.42 lakh crore as on October 4, while its net market borrowing for the same period stood at Rs. 3.40 lakh crore, according to data provided by the central bank. An RBI report also indicates that as per budget estimates for 2019-20, states’ fiscal deficit is projected at 2.6% of GDP. State governments’ net market borrowings stood at Rs. 1.55 lakh crore as on October 4, RBI data shows.

Experts believe that although the rate cut cycle seems to be at the bottom, there could be some more monetary easing considering the negative macro-economic conditions. Recently, State Bank of India (SBI) cut the GDP growth forecast for the second quarter down to 4.2% while also revising the FY20 growth forecast to 5%.

MS Gopikrishnan, independent market expert, said the lower growth projections are helping boost expectations of a further rate cut and that is keeping the bond yields grounded. “We may be at the trough of a rate cut cycle but I still believe that a 15 bps cut may be possible in the December monetary policy. As far as growth is concerned, rate cut may not be an effective tool anymore. Further infusion of liquidity as well nudging banks to lend more to NBFCs will do more to bring confidence into the system as well as spur growth rather than further rate cuts,” he said.