Budget Holds The Key Even As Bond Yields May Rise

Yields may rise in the short end, but budget holds the key

The government borrowing program and the budget provisions could influence the markets in the coming weeks. Almost 20% of the borrowing program of the central government and quite a big chunk of the state government borrowings is yet to hit the markets. There is also a possibility of some additional borrowings from the central government this financial year. This is one part of the matter. On the other part is the borrowing program for the next financial year. It is expected that the next year's borrowing could be higher by Rs 3 lakh crores which may take the gross borrowing program for the next year beyond the Rs 15 lakh crores mark.

The call money rate is trading close to 6.30% tracking the repo rate, and the falling interbank liquidity. Liquidity has dwindled and the pressure on short-term rates is gradually going to show up in the short-term rates. The Treasury bill rates at the primary have been at 6.30% in 91 Days, 6.74% in 182 Days, and 6.89 in 364 Days. The 7.26% GOI 2032 is currently at 7.35%, and as things stand at present, it is set to rise further toward the earlier highs of 7.50%-7.60%.

May witness a scramble for funds toward the end of March

The latest credit growth has been reported at well above 17%, and this is much higher than the deposit growth at 9%. It is highly likely that there could be a scramble for funds as we approach the last three months of the financial year. This stems from the fact that interbank liquidity is very low, and the banks will need to offer higher rates on deposits to gather enough money. In fact, the process of offering higher rates has already started. Even though a significant amount of market-led borrowing has shifted to the banking system, there would still be some borrowings coming into the markets from corporates. The CD and CP rates in the 6 months to one-year maturities are likely to saturate as we move towards year-end. These factors point towards higher short-term rates and an upward shift in the short end of the curve.

Higher government outlay may put some pressure on liquidity

The free grains program which is going to benefit 80 crores of people and the extension of the PLI scheme to more sectors is also going to cost more in terms of government outlays. This may put some pressure on the markets given the fact that the interbank liquidity is less than Rs 1 Lakh crore as of today. The borrowing program becomes more difficult in the absence of liquidity to support it, and it cannot be ruled out that early next year RBI will not initiate some measures by which conditional liquidity expansion will be attempted. Also, the fact that most of the borrowings are concentrated usually in the longer maturities could also bring in some pressure at the long end later in the year.

The repo rate is now at 6.25% and the probability of it being hiked by 25 bps each in another two consecutive rate hikes cannot be ruled out. Inflation is under control, and it has come down to the ceiling level of the RBI target range at 6%. The US Fed's stance continues to be hawkish and there will be another two or three hikes in the Fed Funds Rate as the inflation persistence is high. Therefore, even if the domestic inflation trends are slower RBI will not be able to stop hiking rates even if it is going to be moderate. This is because, as indicated earlier the local currency needs to be supported through rate hikes till the US rate hikes gradually moderate and reach saturation levels. Therefore, the role of external factors in the trajectory of interest rate movements becomes crucial.

While the regular debt products from the mutual fund space and the direct bonds are available, the investment preferences should still continue to be at the short end of the curve. Once the long-end yields attain saturation at 7.45% or beyond, on the Ten-Year Benchmark, investments could be initiated at the long end like gilt funds. Yet another interesting aspect of investments in fixed income at this juncture is the growing prominence of credit risk funds and alternate investment funds. The portfolio yields of some of these funds are quite attractive and have a reasonable balance of liquidity and credit risk profile. Over and above this the average maturity profile is two to three years on an average. This avenue is gradually becoming attractive for long-term investors, especially in light of the demand for corporate credit rising in recent times. This would also have an embedded view that the potential for a further rise in yields might be limited compared to the up move seen so far.

(The article is taken from a report of Emkay Global)