Why volatility is back to haunt bond markets?

The party in bond markets that began with the Centre lowering the borrowing programme for the first half of 2018–19 and the RBI topping it up by a sanguine inflation outlook, is fizzling out. The yield on 10-year G-Sec has shot up by about 30 basis points over the past two to three days. The March CPI inflation moderating to 4.3 per cent from 4.4 per cent in February has also failed to enthuse bond markets much.

The recent surge in crude prices, the calendar of market borrowings by state governments implying a sharp rise in gross issuance and the aggressive profit booking by PSU banks appears to have played spoilsport to the recent bond rally.

Mixed inflation signals

Thanks to the sharp fall in food prices, CPI inflation has been trending lower, now at a 5-month low. But despite this, concerns over the future trend in inflation persist.

For one, core inflation (excluding food and fuel) has been moving up over the past few months, which is concerning. In fact, from 4.5 per cent in March last year, core inflation has moved up to 5.4 per cent in March 2018. Housing inflation, has been moving up since July last year, from 4.9 per cent in July to 8.3 per cent in March 2018. The rest of the components under core inflation—education, recreation, transport, personal care and health—have also been moving up. Given improving domestic demand conditions, core inflation is likely to edge up in the coming year.

Two, the CPI inflation for the fourth quarter of FY18 at 4.6 per cent is a tad higher than the RBI’s recently revised forecast of 4.5 per cent. Aside from the rise in core inflation, fuel prices that have started to creep up could exert upside risk to the RBI’s CPI estimate of 4.7–5.1 per cent during first half of the current fiscal. Remember, fuel inflation has been falling over the past four months, aiding lower CPI inflation reading.

Hence if the fuel prices continue to spike and core inflation persists its upward trend, the RBI may revise its stance. These concerns continue to rankle bond markets.

States’ borrowing plan

Aside from the Centre’s fiscal policy, the fiscal burden of states also has a bearing on the bond markets. In the recent years, states’ market borrowings, are increasingly becoming comparable to the central government borrowing programme. Share of states’ net borrowings in the combined (state and centre) borrowings have risen from 24 per cent in 2012–13 to 43 per cent in 2017–18.

The RBI announcing the calender of market borrowings by state governments for the first quarter of FY19 (April-June) has also spooked bond markets over the past few days. The gross borrowings is expected to be in the range of ₹1,15,600 crore to 1,28,100 crore — this is significantly up from ₹ 64,955 crore in the same period last year. The flooding of SDLs (state development loans) is turning bond markets jittery.

On a selling spree

After the RBI granted banks the leeway to stagger their mark-market losses on their bond portfolio for the December and March ending quarter, PSU banks appear to have sprung into action. Making use of the sudden fall in yields after the Centre lowered its borrowing programme, PSU banks have been aggressively booking profits and selling government bonds.

Data from the Clearing Corporation of India (CCIL) shows that PSU banks have been net sellers in government securities to the tune of around ₹14,845 crore between March 26 and April 6. After being net buyers through most of 2017–18 (to the tune of about ₹63,300 crore between April to December 2017), PSU banks have turned net sellers to the tune of around ₹33,000 crore in the January-March 2018 quarter. Continued selling could add to bond market woes.

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