MUMBAI, Aug 14 (Reuters) - A rally in Indian government bonds, spurred by a large and surprise reduction in policy rates last week, has been cut short by renewed fears of government profligacy.
Since February, the Reserve Bank of India has cut the key policy rate by 110 basis points, which has pushed bond yields down significantly.
Ten-year yields hit 6.30% on Aug. 7, the day of the RBI’s larger-than-expected 35 bps rate cut, and had fallen about 1.2 percentage points since February through the day of last week’s cut.
Over the past four trading sessions, however, bonds have given up some of those gains with the 10-year yield up 31 bps on growing worries the government will boost heavy stimulus and borrowings to quickly accelerate growth.
“Expectations of a fiscal stimulus package seem to be gaining ground in the domestic market on the back of weak economic data and heightened slowdown concerns in the economy,” economists at HDFC Bank wrote in a note. “We believe this could continue to pose as an upside risk to bond yields in the near future.”
Despite much prodding by regulators, Indian banks have been reluctant to fully pass on the benefit of the policy rate cuts to their borrowers.
That is despite the government front-loading its spending for the year and the RBI injecting significant cash into the money markets.
In its budget proposals last month, the government set an ambitious fiscal deficit target for the year of 3.3% of gross domestic product, signalling its commitment to financial discipline despite economic growth languishing at near five-year lows.
But comments this month by Finance Minister Nirmala Sitharaman stating plans to improve the economy “fairly quickly” and speculation that there could be budget changes or new sector-specific stimulus have the bond markets worried.
Traders expect some small fiscal slippage and likely additional borrowing of around 400 billion rupees ($5.60 billion) above the targeted borrowing of 7.1 trillion rupees for the 2020 fiscal year.
Swings in global risk appetite and demand for risk-free sovereign bonds have also added pressure, traders said.
“Uncertainty over sovereign bonds is adding to the selling in bonds along with profit booking,” said Paresh Nayar, head of fixed income and currency trading at First Rand Bank. “But the slowdown will call for more rate cuts.”
Last week, a Reuters poll predicted the RBI would ease its benchmark rate by 25 basis points again to 5.15% at its October meeting, followed by a 15 basis point cut in the first quarter of 2020.
The rate cuts are expected to push down shorter-dated yields more than longer-dated yields, leading to a “bull steepening” of the yield curve. ($1 = 71.4070 Indian rupees) (Editing by Vidya Ranganathan and Sam Holmes)