There are five major influences on the fixed income market, which are marked clearly as of now. These are the liquidity conditions, the government borrowing program, the trajectory of bond yields in the developed markets, the inflationary expectations and finally, the RBI policy. In the last one year the RBI has been extremely supportive of the economy and the markets from the liquidity angle, as sufficient liquidity has been maintained so far, and this helped the banking system and thereby, the business and industry. In the light of the aggravating second wave of the pandemic, the RBI is likely to continue with its current liquidity policy.
A second factor is the huge government borrowing program, which is to the tune of Rs.1.15 lakh Crs, on an average. For such a large amount of primary issue from the government to go through smoothly and in a non-disruptive manner, RBI needs to step in and ensure there is adequate liquidity in the system to absorb the fresh issues of securities. This will be a major requirement which the RBI will have to address on a continuous basis as any going back on this count may result in the issues not being subscribed or the yields moving up to levels where it may make sense of subscribing to the fresh issues.
This assumes far greater importance due to the rise in bond yields in the many developed markets, the notable being the US. While this rise seems to have halted for the time being, the expectations are that US Ten Year Benchmark yield could go anywhere upwards of 2% towards the end of this year as economic growth is quite robust and employment had picked up, and inflationary expectations are rising. This will pose a challenge to markets and policy makers in many countries.
In India too, the level of inflation is high, and it is likely to remain elevated due to rise in oil prices and a weaker Rupee, while growth is expected to be better than the last two quarters. Therefore, the confluence of many factors makes the policy choices difficult and at the same time driven by conflicting objectives. This is where the RBI policy becomes very relevant like at no other time in the past.
RBI has retained the accommodative stance of the policy and also kept the policy rates unchanged. The TLTRO as well as the bank funding for NBFCs has been extended and this gives lot of comfort to the financial markets. The decision to conduct a secondary market acquisition of government securities to the tune of Rs.1 lakh Crs is a measure that will be beneficial to the markets. This will reduce the burden on the markets as an amount equivalent to Rs.1.15 Lakh Crs by way of primary government security issues is going to hit the markets every month. And this will have an adverse impact on liquidity which can be moderated to some extent by this acquisition by the RBI. An enhancement of this limit in future cannot be ruled out. But this would depend on the assessment of the actual impact of the operations and the auctions. This is a positive step in containing the rise in yields of local currency bonds. The broad range for the 10 year benchmark is 5.90% to 6.30%.
The approach to fixed income portfolios remains unchanged as the accent will be on short end products and portfolios which carry low or minimal interest rate risk.
