DEBT MARKETS JOURNEY POST BUDGET
I have not written on debt markets since almost January 2010 post the Credit Policy Review. One of the reasons was that I was waiting for the announcement of Budget and subsequent borrowing calendar. I had hoped that we will have a clear path in debt markets based on the Budget announcements and borrowing calendar announcements.
However, this event (read Budget) has had an effect of creating more ripples in an otherwise calm market. There have been many announcements (like petrol price hike, excise duty hike, etc) which will impact inflation & debt markets in the short run but will go a long way in improving fiscal deficit numbers in the long run.
Let us analyse the debt market situation of last couple of years v/s what is likely to be going forward:
- There was Fiscal stimulus announcements followed by expansionary monetary policy measures over past couple of years to fight the slowing down economy
- Monetary policy measures included aggressive rate cuts alongwith reduction of CRR
- Inflation had actually gone into near zero/negative territory for quite a major portion of the year
- To counter huge borrowing programme due to Fiscal Stimulus package, RBI had a clear OMO calendar to ensure smooth sailing of these auctions
- There was huge liquidity overhang of more than Rs.1 lac cr due to aversion to taking risk, economic slowdown & subsequent lack of credit offtake
As against the above, going forward debt markets will have to weather following hurdles:
- Fiscal stimulus roll back (though good from the point of view of better revenue collection figures) of hike in excise duty to add fuel to already blazing inflation numbers
- Petrol price hike (again excellent in the long run to reduce petroleum subsidy & fiscal deficit numbers), extremely inflationary in the short run
- Hike in CRR by 75 bps in last policy review will put premium on liquidity going forward. Reverse REPO figures have come down from nearly a high of Rs.1 lac cr to currently at close to Rs.30,000 crs & likely to reduce further post the advance tax outflows on March 15
- Due to hike in CRR, very unlikely that RBI will have a definite OMO calendar (which will be counter productive to this hike). Hence, a huge borrowing programme without any support from RBI (in terms of giving back liquidity to the market through OMO) will be very difficult task for the debt markets
- To top it all, old benchmark 6.35% 2020 will be phased out soon making it illiquid as auctions going forward will be of new benchmark papers. Almost Rs.45-50,000 crs of old benchmark will come up for trading; thereby putting downward pressure on its pricing
- Inflation likely to go beyond RBI estimates of 8.50% & may peak off at around 10%; thereby forcing RBI to increase benchmark rates in April 2010 policy review. Inflation can only settle around 5% mark somewhere in August/September due to base effect coming into play
- RBI has clearly indicated that the borrowing calendar would be front loaded & almost Rs.3.50 lac crs would be borrowed in the first six months, which is almost Rs.50,000 crs p.m., which is almost Rs.10-12000 crs every week. Hence, borrowing calendar week on week will be similar to last year’s except for the comfort of having an OMO calendar to support the weekly auctions
- Another uncertainty which can creep in going forward is the state of monsoon. If we have a similar year as last year wherein the monsoon was erratic with drought like situation in certain areas (main reasons for extremely high food inflation in the current year), debt markets will have no respite from the already heavy burden of huge borrowing calendar (without any monetary measures support from RBI)
- Also there is demand/supply mismatch in the Fiscal 2010-11 in favour of supply which can drag G sec prices down
- Only with lowering Fiscal numbers & growing GDP numbers in subsequent years will this be corrected & go in favour of more demand & less supply over next couple of years
Taking into account the above factors one would be best advised to stay away from taking any long term investment calls in the debt markets at current levels. Interest rates have started hardening both at the shorter end (more so in this segment of the yield curve) as well as on the longer end. 1 year CDs which were quoting at 5.75% in January 2010 have already hardened to 7% plus in a very short span. 5 year AAA Corporate Bonds’ yield has hardened to 8.75% from a low of 8.40% pre Budget & 10 year benchmark has marginally gone up from 7.80% to 7.90-7.95%.
With imminent hike in inflation numbers, there will be an imminent rate hike in the near future. Add to this the liquidity woes & huge weekly borrowing calendar; benchmark rates in such a scenario can breach 8% mark soon & may hover between 8.25% to 8.50% levels in the near future. Hence, instead of trying to outguess RBI moves or debt markets, one can safely invest in say 3 month FMPs at or around 6% levels, go beyond March 2010 & let inflation peak off somewhere at 10% levels between April & June 2010 before taking a long term call on debt markets at those levels.
Both for technical (good opportunity to invest at higher yields as well as lower borrowing programme in second half) & fundamental reasons (base effect on inflation bringing the inflation numbers to around 5% in August/September 2010) it will make an immense sense to invest in long term Income/GILT schemes at that point in time.
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