A populist Budget 2018 may lead to yet another bond market sell-off

“The market has already factored in Rs 6.5 lakh crore, so the current sell-off is indicative of that,” said Dwijendra Srivastava, Chief Investment Officer – Debt, Sundaram Asset Management Company. “Anything above that will send a negative signal to the market and could result in a sell-off.”

Srivastava said that the primary concern among market participants at the moment is about how the increased supply of bonds gets absorbed by the market.

Banks are currently holding government bonds in excess of what they are required to for maintaining Statutory Liquidity Ratio (SLR) and foreign institutional investors already hold the maximum possible amount of government securities.

Any increase in limits for FIIs is not a certainty and will be marginal given the increased borrowing. Increasing FIIs limits for holding government securities comes with a risk of increased volatility in the market.

Other bond buyers like insurance companies, pension funds and EPFO will together absorb some of the bonds being issued. But since they are by no means the largest buyers of government bonds, this will not make much of a difference when it comes to generating enough demand to meet the increased supply.

Then there is the question of how much one can trust the government’s borrowing figure. Only last month, the government had announced that it intends to borrow an additional Rs 50,000 crore through issue of dated securities in this fiscal year. The announcement was the first of its nature in six years.

The news was not received well by the bond market and it sold off immediately. But what confused market participants was that a couple of weeks later, the government announced that it would need to borrow only Rs 20,000 crore in addition to the budgeted amount, as against the Rs 50,000 crore announced earlier.

“The borrowing figure and any deviation in it is definitely going to be a trigger for the market,” said R Sivakumar, Head – Fixed Income, Axis Mutual Fund. “Anything under the expected amount will be received well. But more than the figure itself, the bigger point of concern for the market is the supply-demand situation.”

Explaining this, Sivakumar pointed out that the concern for the market is not one of rising interest rates, since rates are currently around the same level as they were a year and half ago but bond yields have shot up significantly in the interim.