See bond yield at 7.7% by mid-March: Nomura

While the Government's cancellation of the bond auction came as a surprise, the bond market is likely to see 7.7% yields by mid-March if the Union Budget is supportive believes Neeraj Gambhir, managing director and co-head, Nomura.

The Government cancelled the auction raising hopes that it will be able to contain its fiscal deficit within target. Gambhir, however, doesn't see too much of a rally in the bond market as of now. "Even with the reduction in the fiscal deficit in the Budget, we will still be staring at a fairly large government borrowing program for the next year," he adds. Below is the edited transcript of Gambhir’s interview to CNBC-TV18.

Q: Do you expect to see a more extended reaction on the yields? Or is this about it in terms of the news that the government had cancelled its auction?
A: The cancellation of the auction came as a bit of a surprise to the market. We were expecting the government to carry through it notwithstanding the fact that they are sitting on a large amount of cash surplus. However, the fact that they chose to cancel the auction was a bit of a surprise and the market reacted to that.
Going forward, for the month of February and March, there is not any additional supply which is left. In addition, we have the Union Budget that will be announced in the end of February. So, both of these things should kind of keep the market supported. If we close below about 7.80 percent levels in the yields, I think we should probably target about 7.70 percent kind of level. We don't expect a big rally to happen at this point in time because even with the reduction in the fiscal deficit in the Budget, we will still be staring at a fairly large government borrowing program for the next year. Q: Post the cancellation of this auction, what are your expectations on the Open Market Operations (OMO) calendar between now and the end of the fiscal?
A: The short fall of liquidity in the system is pretty acute at this point in time and it is about Rs 1.3 trillion. The government or the RBI has to continue to do the most to make sure the liquidity shortfall does not go beyond a certain level. Even if RBI does about Rs 30,000-40,000 crore worth of additional OMOs, towards the end of March, the liquidity shortfall for the banks will probably escalate to about Rs 1.6-1.7 trillion. So, just to make sure that the liquidity shortfall does not go beyond a certain threshold, one needs to continue to supply that long-term liquidity in terms of market.
We don't anticipate the government spend in a big way. On top of that, the advance tax collections in the month of March will add to the liquidity shortfall. So, given all that, I feel atleast Rs 40,000-50,000 crore worth of OMOs have to hit the market. Q: The government has been successful in cutting expenditure over the last couple of months and that is showing up in the cancelled auctions. If you see more evidence of that in the Budget and we get to a credible 4.7-4.8 percent target for next year, do you think yields could collapse to 7.7 percent?
A: Yes, 7.7 percent yield should probably happen by middle of March if the Budget is supportive. I think any fiscal deficit number which is around 4.8 percent or slightly better than 4.8 percent, should keep the market well supported.
Bear in mind that even at 4.8 percent, the fiscal deficit number, the next year’s borrowing program in both gross and net terms is likely to be higher than what we saw this year. So, that will continue to weigh on the market. A larger and a substantial rally is not likely to happen just because the fiscal deficit numbers are coming down.
The other factor which is kind of weighing on the market's mind is this entire move towards held-to-maturity (HTM) cut. HTM reduction is going to free up a lot of stuck supply in the hands of large banks which can come into the market. So, I think both of these factors are currently sort of in the negatives for the bond market yields to come down in a big way.

Q: On that borrowing figure though, what is it that the money market has priced in as a best case and worst case because last year the obsession was with the borrowing program size. This year they just want to hear the magic fiscal deficit figure?
A: The obsession around the borrowing figure starts somewhere towards the middle of March because one has to prepare for getting into the next year and one has to worry about what the auction calendar looks like. At this point in time, the focus is around what fiscal deficit number we will end the year with and what fiscal deficit we are going to target for the next year. I don’t have the exact numbers with me, but I feel about USD 5.7-5.8 trillion is the gross borrowing program which should be pretty much or slightly higher than this year’s borrowing program even with a cancelled auction, assuming a 4.8 percent fiscal deficit target. Q: If those two figures come through, should the money market expect to see the Reserve Bank move on rates as early as March because their commentary has been cautious?
A: Even with a reduction in fiscal deficit down to 4.8 percent, Reserve Bank will continue to be cautious for two reasons; one is that clearly the inflation is still fairly high, the CPI inflation numbers are fairly high. Secondly, they have sort of articulated that we probably have hit the low on growth and we could see some cyclical upturn in the growth going into FY14. So, I do feel that on both these counts, the Reserve Bank will continue to play a bit cautious on substantially reducing the rate as has been sort of indicated by Governor's statements.