10-year G-Sec yields to inch up by fiscal-end despite RBI holding rates

Bond yields that eased over the last week on the back of RBI’s liquidity measures and the Centre’s announcement of a lower borrowing programme for the second half of the fiscal, are set to rise hereon. This is despite the RBI handing bond markets a sweet deal by holding rates. The yield on 10-year G-Sec also moved only slightly lower to about 8.04 per cent post policy indicating that bond markets are not factoring any long term respite from the RBI’s move.

While the Centre lowering its borrowing target by a tidy ₹70,000 crore for the second half of FY19, has offered interim respite to bond markets, shortfall in GST collections and meeting disinvestment targets are key risks to Centre’s fiscal deficit target of 3.3 per cent of GDP for FY19. This alongside surge in global crude prices, depreciating rupee and the trickle down impact on inflation will keep yields high. The 10-year G-Sec yield is likely to inch to 8.2- 8.25 per cent-mark by the end of FY19.

Interim relief

In a bid to ease liquidity, the RBI recently increased the Facility to Avail Liquidity for Liquidity Coverage Ratio (FALLCR), from the existing 11 per cent to 13 per cent of banks’ NDTL (net demand and time liabilities)—essentially implying that banks can now dip more into government bonds held under SLR, easing up liquidity pressure in the banking system.

This coupled with the RBI announcing an Open Market Operations (OMOs) — buying of government bonds—for an aggregate ₹36,000 crore in October, has soothed bond market in the interim.

The Centre on its part reducing its budgeted gross borrowing for FY19 also relieved the markets. For FY19, the Centre had pegged in a gross borrowing of about ₹6.05 lakh crore. About ₹2.88 lakh crore has been raised in the first half of FY19. For the second half, the Centre has set a borrowing program of ₹2.47 lakh crore which cuts back the gross borrowing for the entire FY19 by ₹70,000 crore.

All these factors led to yield on G-Sec cool off last week.

However, the respite is likely to be short-lived even as the RBI has held its repo rate in the latest policy. Risks to fiscal slippages, global factors, depreciating rupee and upside risk to RBI’s inflation projection is likely to lead to hardening of yields in the coming months.

Fiscal worries

Fiscal deficit has reached 94.7 per cent of the target up to August. While the Centre is optimistic around direct tax collections, it may not be enough to make up for the shortfall in GST collections.

The latest provisional figures of direct tax collections up to September, show that gross collections have grown by 16.7 per cent YoY. Growth in corporate tax collections has been higher than expected (19.5 per cent vs. 10.2 per cent budgeted), and the growth rate for income tax collections too is healthy (19.1 per cent vs. 19.9 per cent budgeted). While the overall direct tax collections (if the current pace of growth continues) could exceed the targeted amount by ₹15,000-20,000 crore, it may not be enough to offset the shortfall in GST collections pegged at about ₹30,000-40,000 crore by market players.

On the disinvestment front too, the Centre’s ₹80,000 crore target for FY19 appears a tall task. Up to August, ₹9,400 crore has been raised through disinvestments. Weak equity market sentiment is likely to make it difficult for the Centre to meet this target.

All in all even if higher collection from small savings (achieved 31 per cent of the targeted ₹75,000 crore by August) and direct tax collections offer some comfort, the Centre sticking to the cut back of ₹70,000 crore in its borrowing programme remains uncertain (unless there is reduction in the budgeted expenditure, unlikely in an election year).

Bottom Line

The yield on the 10-year G-Sec will likely move towards 8.2-8.25 per cent by the end of FY19. As longer duration bonds are more sensitive to interest rates, investors should avoid investing in longer term gilt funds. Investors with a low to moderate risk appetite, with a similar investment horizon, can invest in short duration funds that carry lower interest rate risk.

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