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Informist, Saturday, Feb. 1, 2025

 

By Aaryan Khanna

 

NEW DELHI – The gross borrowing target for 2025-26 (Apr-Mar) is higher than what the bond market had to absorb in the current financial year, but the supply next year may go down easier with a little help from the Reserve Bank of India.

 

According to the FY26 Union Budget presented by Finance Minister Nirmala Sitharaman Saturday, gross market borrowing for next year is set to rise to INR 14.82 trillion from INR 14.01 trillion in FY25. Net borrowing is seen just a shade lower at INR 11.54 trillion compared with 11.63 trillion in the current year.

 

In the current year, a major source of demand for bonds was foreign investment as India made its debut on global bond indices. Next year, the support will come from the RBI, both through easier monetary policy and its own gilt purchases under open market operations.

 

"We expect the 10-year bond yield to inch lower over the coming weeks as fiscal deficit for FY25 is lower than budgeted and is targeted to reduce further in FY26," HDFC Bank said in a note. "Expected cuts by RBI, lower US yields, and an expected improvement in FII debt flows are expected to support domestic yields." The bank sees the 10-year gilt yield at 6.55–6.75% in Apr-Jun and 6.3-6.4% by the end of 2025, against 6.70% on Friday.

 

The first gift from the central bank is seen coming as early as next week, when its Monetary Policy Committee meets to decide on the policy repo rate. The new-look MPC--five of the six members have only joined the panel in the last six months--will be chaired by new RBI Governor Sanjay Malhotra, and is expected to cut the policy repo rate for the first time in nearly five years. With CPI inflation seen persistently near 4.5% in the coming quarters and hitting the RBI's 4.0% target in Jul-Sept, the market expects the MPC to address the slack in growth. GDP growth is seen slowing to a four-year low of 6.4% in FY25.

 

Even with the Budget announcing widespread tax cuts, bond dealers said there was no shock or move away from fiscal consolidation that would prevent the rate-setting panel from cutting the repo rate of 6.50% by up to 75 basis points until March 2026. As such, traders' interest in bonds may boom, with increased risk appetite as monetary conditions ease. Banking system liquidity has been near neutral on average in FY25. 

 

"Providing liquidity is important, as is easing the price of that liquidity. Amidst decelerating inflation, a brief respite from a one-way dollar rally, signs of soft domestic demand, and ongoing fiscal consolidation, onus is on the monetary policy to assume a growth supportive tone," DBS Bank said in a post-Budget note. The bank expected the borrowing programme to be neutral for bonds.

 

As global financial markets remain volatile, and the RBI keeps selling dollars to support the depreciating rupee, it is expected to continue selling bonds in the open market to make up for the liquidity it drains through its foreign exchange operations. Moreover, it has a massive outstanding forward dollar sales which will eventually have to be settled. Consequently, market estimates place the RBI's bond purchases in FY26 at nearly INR 2 trillion.

 

The central bank has already shown its intent in recent weeks, picking up over INR 500 billion of gilts through open market operations over the last three weeks, with data likely to show further secondary market buys in that period. For the week ended Jan. 24, the RBI conducted its largest weekly screen-based purchases in nearly four years, at over INR 200 billion. On Thursday, it also bought gilts at auction for the first time since September 2021.

 

Following the bond-buying blitz in the secondary market, the RBI also acted on the market's suggestions for infusing durable liquidity through other means. A six-month dollar/rupee buy/sell auction was conducted on Friday, a long-term variable rate repo auction is coming next week, and more OMO auctions to buy bonds worth INR 400 billion are scheduled in February.

 

The RBI's appetite for bonds is only expected to grow as it looks to expand a balance sheet that is consistently getting pinched on foreign exchange assets by spot dollar sales to protect a slide in the rupee. The RBI's outstanding sales of dollar/rupee forward contracts climbed to a new high of $67.94 billion at the end of December, which poses a further risk to its forex assets. At such a time, QuantEco Research expects the RBI to buy INR 3.0 trillion worth of bonds through open market purchases by March 2026.

 

This would be more than enough to offset the expected slowdown in foreign investment. Government bonds with no caps on foreign investment have drawn nearly INR 1 trillion of investment amid their inclusion on global bond indices in FY25, and while rate cuts may attract some FPIs, the pace is expected to halve next year barring a positive surprise. One disappointment from the Budget that reverberated around the market was that it did not immediately make a case for a rating upgrade despite laying out a fiscal consolidation roadmap to bring down the Centre's debt-to-GDP to near 50% by FY31. Moody's Ratings said as much in a comment published after the Budget. 

 

In fact, the immediate reaction from traders may be negative on Monday, with the 10-year yield seen rising as much as 5 basis points to 6.75%. But state-owned banks and other investors are seen putting their money back right into gilts ahead of the MPC rate decision on Friday. The panacea is likely to be unmissable for traders hunting for immediate gains.

 

Most importantly, there are no questions of whether supply will need to be pushed through – long-term investors' annual demand for bonds grows at over double the sub-6% increase in gross borrowing. Even banks' appetite for bonds is likely to be firm in FY26, with or without tightened liquidity coverage ratio norms, which could drive up demand for government bonds starting Apr. 1.

 

With such a magnificent platter, even the chunkier main course is only seen as a nibble. And traders still expect the 10-year gilt yield to approach 6.60%, rather than surge past 6.75%, when the RBI throws its hat into the ring in earnest next week.  End

 

Edited by Akul Nishant Akhoury

 

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