Markets to focus on liquidity measures and final budget for long-term guidance on bond yields.
The exit poll results predicting the outcome of India's 17th Lok Sabha elections sent bonds soaring on May 20, as markets cheered a likely win for a second time for the PM Narendra Modi-led government.
The benchmark 7.26 percent bond maturing in 2029 ended at Rs 99.81, its highest since April 3, from Rs 99.29 at the previous close. The 10-year benchmark yield fell to 7.29 percent on May 20, from 7.36 percent at the previous close, posting its biggest single session fall since February 28.
"Market is looking for some continuity in policy rather than a populist budget. Nevertheless, the full budget will be awaited before the market can take a decisive view on which way the rates are headed," said R Sivakumar, head-fixed income, Axis Mutual Fund. He said markets will see whether the targets announced in the interim budget are maintained.
The exit polls that were released on May 19 showed that BJP-led National Democratic Alliance will bag 242-365 seats out of 542 constituencies, making it fairly easy to form a government that requires a minimum score of 272 seats. The election results are scheduled on May 23.
"In our view, the priority of the next (possibly same) government will be to revive economic growth and investment although the macro-economic set-up is not very favourable," analysts Sanjeev Prasad, Sunita Baldawa and Anindya Bhowmik from Kotak Securities said in a report.
They expect broad monetary stimulus in the form of policy rate cuts of up to 100 basis points, a cut in cash reserve ratio by 100-200 bps and higher limits for Foreign Portfolio Investors (FPI) in government bonds in order to increase inflow of foreign capital (savings) to make up for the decline in domestic savings.
The Monetary Policy Committee (MPC) that has cut policy rates by 50 basis points since February, is next slated to meet on June 3-6. "There are good reasons for a rate cut, given that the inflation is low and various indicators of growth continue to show weakness. However, the central bank should focus more on liquidity measures, to ensure that even the past rate cuts are transmitted into the system," said Sivakumar.
As per data from the Reserve Bank of India (RBI), liquidity deficit in the banking system has been around Rs 50,000 crore, while the bond yields have been trading in the range of 7.3-7.4 percent. "The RBI probably can afford to wait till after the budget to make the rate decision but the liquidity decision has to be made more urgently," Sivakumar added."Bond yields are unlikely to react to election results for more than one or two sessions. They will be driven by liquidity conditions in terms of measures from RBI and government borrowings," said Madan Sabnavis, Chief Economist, CARE Ratings. "We do not expect the MPC to lower the rates in the upcoming policy. But if it does, the bond yields may ease to 7.25-7.3 percent," he added.
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