Year-ender: Better fundamentals likely to keep bond yields range-bound next year

Government bond yields are likely to remain range-bound in 2023 aided by less aggressive rate hikes by the Reserve Bank of India (RBI) with the central bank drawing comfort from easing inflation, experts said.

“With the inflation under relative control and the overall economy looking relatively better, it looks like we could be in a settled 2023 as far as yields are concerned,” said Manish Jeloka, co-head of products and solutions, Sanctum Wealth.

According to Jeloka, another couple of rate hikes are likely but the bond market indicates that yields have peaked. “We could see similar yields for the next two quarters and then a fall in yields," said Jeloka.

Bond yields and prices move in opposite directions.

Yield to remain range-bound

The yield on the 10-year benchmark government bond should hover around the 7.25-7.50 percent mark and may ease below this range as most negatives are already factored in, treasury dealers said.

According to Ajay Manglunia, managing director and head of investment group at JM Financial, the key trigger for bond yields will be government spending in FY24 and inclusion of Indian bonds in global indices.

Also read: Global economy to feel the heat of monetary policy tightening: RBI Bulletin

Government borrowing key

Money market dealers foresee some volatility in the bond market in the event of the government announcing a higher market borrowing target in the upcoming budget.

According to them, the government may announce an amount almost in line with that announced in the previous budget, but the gross borrowings might be higher due to higher bond repayments due in FY24.

In the previous budget, the government had set a gross borrowing target of Rs 14.95 lakh crore for FY23. This was later reduced to Rs 14.31 lakh crore after the Reserve Bank of India’s (RBI) switch operation contributed Rs 63,500 crore in February.

Moreover, the government had announced that it would borrow Rs 8.45 lakh crore in the first half of the current financial year but ended up borrowing Rs 8.29 lakh crore.

It plans to borrow the balance amount of Rs 5.92 lakh crore (or 41.7 percent of Rs 14.21 lakh crore) in the second half of 2022-23 (H2FY23) through dated securities, including Rs 16,000 crore through sovereign green bonds, according to a finance ministry statement.

Government borrowing is crucial because it plays a very important role in managing its spending needs. In simple terms, borrowings are loans taken by the government to fund its spending on public services. Usually, the government borrows the money through securities such as government securities and Treasury bills.

Pankaj Pathak, fund manager (fixed income) at Quantum Asset Management, said government spending has picked up in the last two years. “We might see another year of low borrowings from state governments as they continue to collect increased taxes,” he added.

Also read: Government to announce higher borrowing in next budget to spend on public works, say experts

RBI’s inflation fight

Aggressive rate hikes by the RBI put pressure on bond yields in 2022. Since the start of the rate hike cycle, yield on government securities, especially on the 10-year benchmark bond, rose sharply and breached 7.50 percent levels. Between April and December, the 10-year bond saw its yield jump 50-60 basis points (bps). One bps is one-hundredth of a percentage point.

In this calendar year, the central bank announced two benchmark bonds.

Currently, the 7.26 percent bond maturing in 2032 is the 10-year benchmark in the market. On Tuesday, December 20, the yield on this bond closed at 7.2991 percent.

The major upward adjustment of the bond yield had happened in the short period between April and June as traders re-priced according to the rate hike and commentary by the RBI.

Even then, Indian bond yields haven’t gone higher compared to those of many of their developing market peers.

Earlier this month, the monetary policy committee (MPC) hiked the key repo rate by 35 bps to 6.25 percent to fight inflation. The RBI has increased the repo rate, or short-term lending rate, by 225 bps since May.

In November, while the headline retail inflation declined to an 11-month low of 5.88 percent from 6.77 percent in the previous month, core inflation continued to remain high at over 6 percent.

The fall in inflation in November follows a similar drop in October, allowing it to fall below the 6 percent upper bound of the RBI’s 2-6 percent tolerance band for the first time in 2022. As for the medium-term target of 4 percent, CPI inflation has exceeded it for 38 months in a row.