Short-term respite to Indian bonds

Radhika Rao, India Economist, DBS Bank and Eugene Leow, Rates Strategist, DBS Bank

Indian domestic bonds are likely to gain today after the government lowered its borrowing program for H1 FY19 (April to September 2018) and reduced the duration of planned issuances. Anticipation of better demand (if FPI limits are revised materially higher) should also support sentiment, with the bounce in risk appetite overnight an added tailwind.These developments would provide some respite to domestic bonds after a combination of weak macro numbers, adverse demand-supply dynamics and higher US rates pushed 10Y yields from 6.5% in August 2017 to 7.7% (generic quote) earlier this month. Yields closed at 7.62% yesterday. With the March fiscal-end books' closing near, a pullback in yields is likely. That said, we are sceptical that the tinkering of the borrowing schedule (kicking the can down the road) would have a lasting impact on bonds. Yields might find support beyond a fall in the near-term.

Under the new plan, H1 borrowings will stand at INR2.88trn, 22% lower than the INR3.72trn announced same time last year. Other key changes include:

The government typically borrows 60-65% of the full-year's planned borrowings in first half of the year, but will start small in FY19 with 47.6% of the annual supply this year. Weekly auctions will thereby be pegged at INR120bn instead of the routine INR150-180bn.

a. Tenor breakdown has been rejigged. More T-bills and a third of the dated issuances will be in the shorter (1Y-9Y) tenors (see chart). This shortens the weighted average maturity of debt from the current 14 years.

b. Full-year borrowings might also be lower than the budgeted INR6.06trn, due to plans to raise an additional INR 250bn through National Small Savings Fund (totalling to INR1trn) and lower buybacks.

c. More inflation-linked and floating rate bonds, on which rates may be lower than the government's papers

d. Fresh investment limits for FPIs are due to be announced in early-April.

Lower borrowings in H1 is encouraging for the short term but there are a few areas of concern for the medium term. Firstly, borrowings were front-loaded in the past to ensure limited crowding-out impact, as credit growth is usually off to a slower start in H1. Second, supply will now get bunched up in H2, at a time when the fiscal run-rate typically turns adverse. At the same time, any risks to the fiscal deficit goals might raise pressure for additional borrowings in H2, especially in the midst of a busy state election year followed by the general elections in mid-2019 (with risks of being brought forward). Accordingly, we are still cautious on the longer-term outlook, beyond the relief rally in the immediate few months. Current tailwinds might become headwinds as a larger supply of bonds looms in H2 FY19.

Source : Equity Bulls

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