MARKET MIND

It has been an interesting year so far for government bonds. Year 2016 began on a cautious note against the backdrop of the first rate increase in seven years in December 2015 by the US. Domestic markets also turned cautious and the benchmark bond saw considerable selling in the run-up to the Union Budget. Heightened concerns about the possibility of significantly higher issuances as a combination of central, state and quasi-state borrowings primarily fuelled the weakness.

It is important to note that subsequently, the global bond market landscape has undergone a sea change. In a marked shift in stance, the US Federal Reserve toned down its rate hike expectations on growing global risk factors. The G20 meeting in Shanghai also led to a seemingly tacit policy coordination among most major central banks, which saw them step up monetary easing considerably. In this process, Europe and Japan have even adopted negative policy rates. Consequently, even long-dated yields in economies such as Germany and Japan have turned negative. The above factors will

SHILPA KUMAR

result in continuing demand for sovereign assets globally and are likely to keep global bond yields lower for longer.

The increasingly lower returns on safe assets will prompt capital providers of the world to embark on a search for yield and they will look towards emerging market assets. Among this cohort, India is well positioned, as it offers relatively high returns combined with a stable and positive macroeconomic and political backdrop. Stability in rupee will also support foreign institutional investor (FII) flows into debt market.

Turning to domestic triggers, government bonds have seen several supportive factors since March. The Budget announcement was crucial, as it allayed fears about a slippage in deficit targets and excessive borrowing. This was further reinforced by easing in policy rates by the Reserve Bank of India (RBI) in April. This decision also marked an important structural shift as it was accompanied by a landmark revamping of the systemic liquidity framework. Consequently, RBI conducted an unprecedented amount of bond purchases in the first three months of 2016-17, which significantly eased systemic liquidity deficit. Recently, with the improvement in global risk sentiment, on the back of increased expectations of policy easing after Brexit, there has been considerable FII interest in Indian government bonds. Against the backdrop of a benign global environment for bonds, evolution of domestic triggers will be important to determine the trajectory of yields going ahead.

The recent surge in inflation numbers have been primarily driven by food inflation. Price levels are expected to subside going ahead on account of normal rains, which would help crop sowing. Additionally, proactive government policy measures taken recently including the concerted effort to rein in inflation in items such as pulses and vegetables have also started to bear fruit and will aid in cooling price pressures.

RBI’s commitment to keeping systemic liquidity close to a balanced level will remain a supportive factor. On the back of stable prices, further policy accommodation by RBI at a suitable time cannot be ruled out. On balance, yields are likely to continue to broadly trend lower in the near term.

But, inflation trajectory remains key and will have to be watched closely as unexpected increases would affect bond markets adversely.