Crude, resurgence of bond supply may push India’s 10-year bond yield up

The benchmark 10-year government bond yield’s downward drift in the past few weeks on reduced supply and a dovish central bank stance may prove to be short-lived.

Bond yields are expected to rise again as global crude oil prices pose a significant risk to India’s inflation outlook.

"This pullback has run into rough weather, as geopolitical risks drive energy prices higher, and the government reinstates a debt sale this week. While earlier auctions were likely scrapped owing to a comfortable cash balance, the recent drop in yield could draw authorities back into the market," said Radhika Rao, senior economist at DBS Bank.

The government has not ruled out additional auctions in March in case its cash position requires it to borrow from the market.

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On February 22, Economic Affairs Secretary Ajay Seth said the government’s borrowing programme was “dynamic” and the market would be informed of any changes.

According to a Reuters report on February 23, the government may conduct more debt auctions after its last scheduled tender for the fiscal year on February 25 to take advantage of the relatively low cost of borrowing.

A large bond supply is due to hit the market in FY23, which begins April 1.

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"With an impending jump in bond supply in FY23, yields are expected to harden further. A sustained bout of high oil prices is a risk to the economy’s inflation (once fuel prices are adjusted post-state polls), fiscal and current account math," Rao added.

In the Budget 2022, the government kept the gross borrowing target for the next fiscal year at Rs 14.95 trillion against an estimated Rs 12- 12.5 trillion.  The government also put the fiscal deficit target for FY23 at 6.4 percent of the Gross Domestic Product, higher than expected.

Escalating geopolitical tensions involving Russia have nudged crude oil prices closer to $100 a barrel. Moscow’s move to order troops into two breakaway regions in eastern Ukraine has increased the possibility of more sanctions against Russia. Russia is the third-largest producer of crude and sanctions could spell trouble for oil supply.

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“The major impact of the Ukraine crisis in India is the implications of crude oil at $97. If crude sustains around these high levels, inflation in India is sure to go up, forcing the Reserve Bank of India to revise up its FY23 inflation target and signal withdrawal from an accommodative monetary stance. This would be negative from the growth and earnings perspective," said Dr VK Vijayakumar, Chief Investment Strategist at Geojit Financial Services.

The benchmark bond yield has dropped almost 20 basis points in the past few sessions and was at 6.88 percent on February 23. Bond yields move inversely to prices.

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The stress on growth and a softer tone on inflation in the RBI’s monetary policy earlier this month and a reduction in bond supply after two auctions were cancelled helped cool yields.