India’s government bond yield curve will get steeper at the short end this year as liquidity progressively tightens, but long-term yields, including the 10-year benchmark, may remain steady or even decline. Of course, the fortunes of the 10-year government bond will depend on the Union Budget for the next financial year.
Neeraj Gambhir, group executive of treasury and markets at Axis Bank, believes that an unchanged market borrowing target for FY24 would be good news for the bond market. “So as long as the budget’s glide path is maintained on fiscal consolidation and the government borrowing size is not very different from what they have done this year, I think the market will be kind of okay,” Gambhir said in an interview with Moneycontrol.
Gambhir believes there are enough levers for bank credit growth to remain robust but companies could relook at corporate bonds for fund-raising as bank loans begin to look expensive with rates hikes. That would result in widening of spreads in the coming months.
Last year was not a great one in terms of corporate bond issuances. What was behind the modest issuance volume?
In May we had a surprise rate hike and subsequently we had a series of rate hikes. So obviously, a very sharp repricing happened in the market and when you have such a sharp repricing and such a sharp increase of interest rates, it takes issuers a bit of a time to get used to the new levels. And that's what we saw happen.
From the investor side, the appetite was also muted, because we saw the overall liquidity in the system come down. Mutual funds saw outflows from their schemes in the initial phase of the rate hiking cycle and that too impacted demand. What has helped is that in the second half of the calendar year, particularly after October, we have seen very strong demand from long-term investors, like pension funds, EPF, insurance etc. All these segments have actually come back very strongly at the longer end of the curve. This explains why, in the last 2-3 months, we saw a good amount of supply of long-term bonds and this supply got sort of very quickly absorbed as well.
We saw some instances of pricing where private sector AAA bonds were priced at par with G-secs or even a couple of times below G-secs, in the 10-year segment? Have these anomalies corrected and why did this happen in the first place?
It was a short phase of time when we saw these happen. Investors have mandates and as end of the year nears, they must fulfil their mandates. If the supply is limited at that point in time, you can see sometimes these kinds of phenomena happen. But in general, what we are seeing is that the credit spreads are extremely tight right now, particularly for PSU issuers. Even if I look at private sector issuers, the credit spreads are on the tighter side of the range, historically speaking. It is effectively telling you that there is demand from these long-term investments, and there is not enough supply and this is why the spreads continue to be quite tight.
Would we see companies come back to the bond market this year?
The dynamics of pricing corporate loans in India is that they are largely linked to MCLR (Marginal Cost of Funds Based Landing Rate) which changes when the deposit rates in the system change. So while the corporate bond market, as we discussed earlier, has gone ahead and priced in the future rate hikes in the earlier part of the year, the pricing adjustment of corporate loans has been a slow affair. Therefore, till now, it made more sense for corporates to tap into their bank lines, rather than go for bonds as the bond market pricing was higher than loan pricing. I expect that going forward this pricing gap between the loan market and the bond market will narrow. Therefore, we may see that some of the corporates which had switched to the loans may start coming back the bond market.
Another factor that isn't getting talked about much is the fact that borrowing in dollars and swapping into INR has become very expensive. Therefore, it still makes sense for a company to say for example, do a rupee bond and not do a dollar bond. To that extent, I think the corporates are looking at the domestic market, whether it is the loan market or bond market, for financing. And that is one possible reason why you're seeing strong credit growth in this year. This trend is also likely to continue for some time.
What is your outlook on government bond yields?
I'm expecting G-sec yields to consolidate now. I don't think that we want to see a big move up in yields from here onwards. Obviously, a lot depends upon what the government does in the budget. So as long as the budget’s glide path is maintained on fiscal consolidation and the government borrowing size is not very different from what they have done this year, I think the market will be fine. Therefore, I don't expect the G-sec yields to actually go significantly either way. I think for now reaching 7.50% on the 10-year benchmark looks difficult.
What have the markets priced in terms of rate hikes? What is your expectation?
If you look at the OIS (Overnight Index Swap) curve, it is basically pricing in another 25 bps (basis points). A 25 bps rate hike is a given in February and there is some probability of another 25 bps also. This is what the curve is telling us now. The G-sec curve is obviously a little bit higher because it is impacted by the fact that liquidity in the system is coming down. So, while the RBI (Reserve Bank of India) rate hikes maybe 25 or 50 bps, the key question is whether the operational rate will be SDF (Standing Deposit Facility) or MSF (Marginal Standing Facility). This depends upon the liquidity in the system. This is what the bond market is looking at.
My expectation is that 25 or maybe 50 bps maximum in terms of rate hikes.
Do you see any possibility of consolidation at the short-end or you think this steep movement will be maintained?
I think the short end could see a little bit more pressure from now until March because we have seen a significant amount of issuance activity in the calendar year from the banking system. The outstanding CDs (Certificates of Deposit) by the banks have actually gone up quite sharply over the last 12 to 18 months. Effectively, as the credit demand has accelerated, the deposit growth has lagged. Banks have also relied more and more on CD market to fund the growth. And that is getting reflected in the spreads in the money market. The spread of one-year CD over one year T-bill is almost 100 basis points. The spreads are elevated at the shorter end of the money market and that is likely to continue very to this year as we go into financial year-end.
Foreign Institutional Investors have been largely absent or exits have happened from the bond market. Should we not expect flows at all now?
There is some uncertainty about when the US rate hiking cycle will stop. If we go by the rate probabilities in the market reflected in the yield curves, the market is expecting another 100 basis points of rate hike with a terminal Fed funds rate somewhere close to 5 percent and thereafter, a period of consolidation.
But the speeches coming out of Fed seem to suggest that there is at least one subsection of the Fed, which wants to keep the rates higher, for a much longer period. Much of that clarity will emerge in the next three to four months when we get to see the data on inflation. My expectation is that while we are looking at 100 basis point kind of rate hike by the Fed, I think it's very difficult for money to move into emerging market assets. Think about this, cash used to earn zero in the US, now it earns 4 percent and soon it could become 5 percent. Until that clarity on US rates emerges, I don't see a big flows coming into the emerging markets. Bond flows will only start when we see a resolution on when the Fed rate hiking cycle stops and when the market starts expecting rate cuts.
The government has announced sovereign green bond issuance. What kind of demand and pricing are you expecting?The issue in India is currently we don't have any green funds. We're not very clear how much of these bonds will attract global interest because they are local currency and not foreign currency. I think there is a bit of a price discovery that should happen here. There is no stopping the domestic investors to otherwise buy these bonds. Demand will always be there. The question is whether the green label is going to give a pricing edge. But that remains to be seen, because we don't have dedicated green funds. For now the pool of investors is the same as G-sec.