Budget 2016: Positive for bond market

Since the announcement of Union Budget 016-17, on February 29, yields on the 10-year benchmark paper have come down by over 15 bps. They are now trading at 7.62 percent, as against 7.78 percent, a day before the Budget was announced. Analysts expect bond yields to hover at 7.50 levels, in anticipation of the next rate cut, for the short term.

Since the announcement of Union Budget 016-17, on February 29, yields on the 10-year benchmark paper have come down by over 15 bps. They are now trading at 7.62 percent, as against 7.78 percent, a day before the Budget was announced. Bond yields and prices are inversely related. Just before the Budget was announced, most market participants had expected bond yields to touch 8 percent levels. However, the budget was more positive for bond market as the finance minister, Arun Jaitley, pegged fiscal deficit for 2016-17 at 3.5 percent of the gross domestic product and said that it is prudent to stick to consolidation. This has also led to expectations for a reduction in policy rates by the Reserve Bank of India (RBI). While the central bank will review its monetary policy next month, on 5 April, most analysts expect the RBI to slash the repo rate by 25 basis points. Markets also anticipate an out-of-cycle rate cut.

On budget day, the benchmark 10-year bond yields came down by 16 bps, to close at 7.62 percent, after falling as much as 18 bps during intraday trading. Analysts now expect bond yields to hover at 7.50 levels, in anticipation of the next rate cut, for the short term. The RBI did not cut rates in its monetary policy review on February 2, but was waiting for the Budget to decide on its next move. “Structural reforms in the forthcoming Union Budget that boost growth while controlling spending will create more space for monetary policy to support growth, while also ensuring that inflation remains on the projected path of 5 per cent by the end of 2016-17,” the RBI said in its last monetary policy.

Going by the current numbers, inflation too has remained within the Reserve Bank of India’s (RBI) indicated trajectory. Consumer Price Inflation or the CPI stands at 5.69 percent in February, lower than RBI’s projected target of 6 percent for January 2016.

On account of liquidity concerns, in the beginning last month, yields on the ten-year benchmark bond were trading higher at 7.83 per cent. The central bank has reduced its benchmark repo rate by 125 basis points to 6.75 percent from 8 percent in calendar year 2015.

With advance tax payments to kick in this month, which would lead to tightness of liquidity in the system, the RBI said it will inject adequate additional liquidity using a combination of appropriate instruments, while continuing with its normal Liquidity Adjustment Facility (LAF) operations. “With a view to addressing the expected tightening of liquidity conditions in March on account of advance tax payments by corporates and in order to provide flexibility to the banking system in its liquidity management towards March-end 2016, the Reserve Bank of India will inject adequate additional liquidity using a combination of appropriate instruments, while continuing with its normal LAF operations. Based on a continuous assessment of the evolving liquidity conditions, the tenor and magnitude of additional liquidity operations will be announced a few days in advance of each tranche,” a RBI release said, last month.

Last week, the central bank said it will infuse Rs 15,000 crore liquidity through open market operations (OMOs) purchase of government securities.

After the June rate cut, bank borrowing under the LAF fell to zero on average, in line with the RBI’s strategy of easing its monetary stance. But around the time of the October cut, banks began to borrow again, demanding an average of Rs 1 lakh crore per day, rising to Rs 1.75 lakh crore per day by February 2016, the Economic Survey said. Short-term market interest rates are most influenced by RBI policy. In the periods following the first three rate cuts, the spread between the 91 day T-bill rate and the repo rate declined. But it increased sharply starting in August and continuing after the rate cut in October, it added.