Bonds in India See Best Year Since 2008 on Modi, RBI Surprises

  • Benchmark 10-year sovereign bond yield slumps 127 basis points
  • Notes rallied even as foreign investors pared debt holdings

India’s benchmark sovereign bonds are set to cap their best performance since the global financial crisis amid record debt purchases by banks, the biggest holders of government securities.

Lenders gorged on debt this year as the central bank boosted cash availability in the financial system and deposits surged following the government’s recall of high-value currency notes. That, along with a reduction in benchmark interest rates, offset the impact of foreign outflows stemming from the Brexit vote, the Federal Reserve’s monetary tightening and a change at the Reserve Bank of India’s helm.

The benchmark 10-year yield has plunged 127 basis points in 2016, the most in eight years, to 6.49 percent in Mumbai on Friday. It sank to 6.19 percent in November, the lowest close since April 2009. The drop in India’s yield is the steepest in Asia.

“Liquidity will continue to be a key factor driving the market for the next two quarters,” said Badrish Kulhalli, a fixed-income fund manager at HDFC Standard Life Insurance Co. in Mumbai. Bonds will continue to perform well as the government is likely to stick to its fiscal-deficit target in February’s budget and the RBI is likely to keep an easy stance, he said.

The following four charts showcase the 2016 performance of India’s bond market:

CHART 1: The Reserve Bank of India’s bond purchases, part of its April commitment to improve money supply in the banking system, drove yields lower. The government’s currency recall -- which saw citizens rushing to lenders to free themselves of the defunct notes -- flooded the system with cash, causing yields to drop further.

CHART 2: The Bloomberg India Local Sovereign Bond Index has returned almost 15 percent this year, the highest in emerging Asia. Even so, the second-highest benchmark yields among the region’s major markets and prospective carry returns are keeping investors including Amundi Asset Management and OppenheimerFunds Inc. interested in rupee debt.

CHART 3: Policy makers cut the benchmark repurchase rate twice in 2016, by 25 basis points each, to the lowest in about six years, following a 125-basis point reduction in 2015. Borrowing costs have declined across the curve, with three-month commercial paper rates falling to lowest level since 2010. Rupee-denominated bond sales by Indian companies have surged to a record 4.41 trillion rupees ($64.9 billion) in 2016, data compiled by Bloomberg show.

CHART 4: While Indian yields plunged, those in the U.S. climbed as the Fed raised interest rates mid-December and signaled a steeper path for borrowing costs in 2017. That’s reduced the gap between local and U.S. Treasury rates, diminishing the appeal of rupee debt for overseas investors. Foreign holdings of Indian government and corporate bonds have declined by 308 billion rupees in 2016, after increasing for two straight years.

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