On Friday, the Reserve Bank of India (RBI) carried out the maiden auction of a new government bond maturing in 2034. The coupon – or rate of interest – for the new bond was set at 6.79%. At the time of the auction, the yield on the existing 10-year bond was trading at 6.80%, implying a premium of one basis point for the yield on the new paper. The existing 10-year bond, which bears a coupon of 7.10%, closed at 6.83% on Friday.
The downward shift in the coupon rate of the new bond indicates the change in the view on interest rates and bond demand-supply that has transpired since April, which was when the old bond was introduced. Government bond yields determine the cost of borrowing across the economy as corporate debt is priced on the basis of sovereign debt. The 10-year bond is the pricing benchmark for the sovereign yield curve.
Agencies“The basic story for gilts this year has been more of demand-supply. There are expectations built around a change in the RBI’s stance, etc, but the story still remains one of extremely strong demand driven by domestic investors and, on top of that, we’re likely to get around $20 billion of FPI buying this year too,” said Shailendra Jhingan, MD, CEO, ICICI Securities Primary Dealership.
On June 28, the process of inclusion of Indian government bonds in a JP Morgan index commenced, driving hefty overseas inflows into local debt. FPI investments worth more than $7.5 billion have flowed into index-eligible bonds from June 27 to October 3, clearing house data showed. Moreover, India’s headline retail inflation has declined sharply since April, with the August print at 3.65%, below the RBI’s 4% target.
On the domestic side, insurance companies and pension funds have displayed strong demand for longer-dated government bonds as a means of hedging liabilities and demand from these players is expected to remain firm, given increasing financial penetration in the economy.Jhingan said, however, that with tensions flaring up in West Asia, concerns had built up over disruptions in oil supplies from the region. The inflationary risk stemming from that scenario could prevent the RBI’s Monetary Policy Committee from shifting to a neutral stance from the current stance of withdrawing accommodation when it details its policy statement on October 9, he said.”I think we would remain in the 6.75-6.85% range for now for the 10-year bond yield,” he said.
The sudden escalation in the West Asian conflict has caused an abrupt realignment in domestic bond views, bringing a phase of falling yields to a grinding halt.
“Before the geopolitical volatility, we could have thought of 6.65%, but I can’t see that sustainably now,” said Vikas Goel, MD, CEO, PNB Gilts.