The tightening of yields was pronounced in the most liquid segment of the debt market: government securities. We have seen 5-year G-Sec yields rise 60 basis points and 10-year yields rise 40 basis points over the past month. The above 10-year G-sec yields rose 30 to 35 basis points. However, the rise in short-term AAA-rated PSU bond yields was smaller, with five-year yields increasing by 40 basis points. The spread, which was 45 to 50 basis points before the policy, has narrowed to 20 to 25 basis points over the past month.
Yields on corporate bonds have outperformed government bonds by a decent margin in the past five months after the introduction of TLTRO (Targeted Long Term Repo) by the RBI. The total target long-term repo auction was Rs 1.12 lakh crore. This amount was to be deployed in the corporate bond market, of which at least 50% was to be purchased on secondary markets. This was done to create liquidity in the secondary corporate bond markets.
The corporate bond supply was around Rs 2.6 lakh crore, the majority of which was in the short end of the yield curve of up to five years. Mutual funds, banks and insurance companies became major buyers in the market for these papers because they met their requirements. Mutual funds received Rs 1.20 lakh crore from April, which was mostly invested in AAA rated papers.
Spreads between corporate bonds and G-Sec narrowed as banks and mutual funds competed to deploy money in those papers. The spread went from 120 basis points to 20-30 basis points up to the five-year segment. The liquidity of the banking system exceeds Rs 6 lakh crore and the Indian economy is expected to remain weak over the next 2/3 years due to the aftermath of the Covid pandemic. This situation should force the RBI to maintain an accommodative monetary policy.
Corporate bond rates are still attractive for companies to borrow, even when yields have risen 30 to 40 basis points in different segments of the yield curve. The MCLR minimum rates that banks charge are above the 7 percent level, and these rates are not expected to drop significantly from those levels. Corporations still have an interest rate differential of 100 to 175 basis points against the banks’ MCLR rates. Companies are expected to borrow more in the debt market as a result of this arbitrage and reduce their borrowing costs.
After the August 6, 2020 monetary policy meeting, the RBI gave conflicting signals to the markets. The bond market is used to the RBI’s intervention in the bond market, when 10-year yields are trading in the 5.90-6% band. Without the support of the RBI, Rs 20 lakh of central government borrowing will not be possible this fiscal year. RBI devalued the 10-year below 6 percent during the primary auction, after monetary policy. This was taken as a signal and the market stabilized after monetary policy. However, the RBI’s policy brief indicated the uneasiness of monetary policy members over the high CPI inflation. This led to higher yields at the primary auction and triggered the sale that followed, as the RBI delayed Operation Twist even when 10-year yields traded above the 6.20% levels. . Some traders who have bypassed the market have started asking for the 10-year yield to rise to the 7% level, where the supply and demand for government securities could match.
The RBI has started intervening in the bond market through Operation Twist for Rs 20,000 crore, and the central bank is expected to continue these operations until the 10-year yield hits the 6 level. %.
In this scenario, government securities should perform well going forward and the spread between G-Sec bonds and corporate bonds, which is currently around 30 basis points, is expected to widen.
Industrial capacity utilization was 69.3 percent in February and our economic growth rate in India for last year stood at 4.2 percent, below the potential growth rate of 6, 5 to 7 percent. Although oil inflation is expected to remain at high levels due to the increase in excise taxes, food inflation is expected to moderate in the coming months due to good monsoon rains. The gradual lifting of foreclosure restrictions is expected to lead to an increase in the supply of goods that should meet the demand for essential food items. Higher rates in the economy can be doomed and reduce the potential growth rate of the economy. We expect aggressive RBI intervention in debt markets to stabilize government bond yields over the coming months.