Bond market now a two-way Street

Mumbai: The Centre's decision to slash motor-fuel taxes appears to have split India's bond markets down the middle, with yields on the curve's short end falling on expectations of moderate policy rate increases and tenured debt yielding higher in anticipation of elevated North Block borrowings.

"The excise cut has allayed apprehensions of sharper rate hikes," said Parul Mittal Sinha, head of financial markets, India, Standard Chartered Bank. "This has brought down the shorter-end yield curve across the bond market. At the same time, concerns over higher fiscal deficit are keeping the long-end yields elevated."

This trend may continue unless the bond market is convinced about North Block's ability to garner higher revenues despite the cut in fuel taxes.


To be sure, New Delhi's borrowing is expected to increase by more than ₹1 lakh crore on account of likely higher fertiliser subsidies.

Government bonds maturing in the next two to five years yielded 4-7 basis points lower, Bloomberg data showed. By contrast, the 10-year benchmark yield rose up to six basis points through the day but closed at 7.39% Monday, versus 7.36% Friday. One basis point is 0.01%. Bond yields and prices have an inverse relationship.

"It is likely that the second-half borrowing target will be revised amid the excise duty cut and higher subsidy bills," said Rajeev Radhakrishnan, chief investment officer, fixed income, SBI Mutual Fund.

Steps Taken
"Shorter duration yields are, for now, under check as the government move would aid in staggering future rate hikes," Radhakrishnan said.

The relatively less liquid 14-year and 30-year sovereign gauges were up 1-3 basis points.

Over the weekend, the Centre decided to cut the central excise duty on petrol and diesel. It provided a subsidy window for cooking gas cylinders, too, amid a spike in consumer prices. Inflation as measured by the Consumer Price Index shot up to an eight-year high of 7.79% in April, with the wholesale inflation gauge rising to a record high of 15.08%.

On May 4, the Reserve Bank of India (RBI) raised the policy repo rate by 40 basis points in an unscheduled monetary policy announcement, citing risks of skyrocketing consumer prices. The subsidy burden and sacrificed auto-fuel revenues might prompt more borrowing by the government, which had earlier planned to borrow Rs 14.21 lakh crore. Dealers expect this gross borrowing target will be overshot.

"With the action on fuel prices, it is now a two-pronged attack on inflation," said Vijay Sharma, executive vice president, PNB GILT. "The first is through monetary response and the second through fiscal response. This will have fiscal implications - in lower government revenues."

This could lead to a steepening of the curve where short-dated securities are well supported due to lower rate increase expectations, while longer securities remain under pressure due to the lurking danger of increased borrowings, dealers said. Analysts expect the reduction in petrol and diesel excise duties could have an impact of about half a percentage point on the headline CPI inflation, factoring in both the direct and second-order effects.