Rate cuts may help sovereign bonds post modest gains despite fiscal woes

More rate cuts from Asia’s most accommodative central bank this year will help India’s sovereign bonds post modest gains despite the lingering fear of the government missing budget targets.

The yield on the new 10-year bond due in 2029 is likely to drop to 6.38 per cent by December-end, and further to 6.30 per cent by March, according to the median estimates in a Bloomberg survey of 12 traders and fund managers. It rose four basis points to 6.51 per cent on Friday.

The $20 billion tax break to companies and the sluggish growth in revenue have led to concerns about the government adding to its record borrowings. At the same time, the central bank has pledged further easing if needed after delivering five back-to-back cuts to boost growth, helping steady the market after a two-month sell-off.

“The possibility of extra borrowings will be a factor that the market will continue to watch,” said Shailendra Jhingan, chief executive at ICICI Securities Primary Dealership Ltd. “But the monetary policy would continue to support yields, primarily at the short end of the curve.”

The government plans to sell Rs 2.68 trillion ($38 billion) of debt in the six months that began Oct. 1. While the size is unchanged from what was announced previously, the administration aims to end the borrowings in January -- two months before the fiscal year ends.

This window can be used to squeeze in extra bond sales, traders say. Finance Minister Nirmala Sitharaman has said she would take a call on the year’s fiscal-deficit goal closer to the federal budget in February.

Rate cuts may help sovereign bonds post modest gains despite fiscal woes

Following are comments from traders and fund managers:

IDFC Asset Management (Suyash Choudhary, head of fixed income)

Scope for some expenditure cut exists but still looking at about 40bps of slippage on the fiscal deficit target. Estimating about Rs 50,000 crore of extra bond supply.

Steeper curves are a logical outcome of the two forces at play: on the one hand, policy rates are going to be lower for longer, and on the other, there’s considerable fiscal and bond-supply risk especially when states are considered as well.

Bullish for rates up to 5 – 7 years as expect some sort of bull steepening to continue.

Edelweiss Asset Management (Dhaval Dalal, head of fixed income)

Constructive on liquid, high-quality and long-maturity bonds.

The hunt for yield is powerful as investors look for opportunities to deploy investment surpluses as companies deleverage and hold back fresh investments.

With this backdrop, investors will be happy to consider investing in long maturity state companies’ bonds at current levels due to their perceived safety, liquidity and superior risk-adjusted returns.

Quantum Asset Management (Pankaj Pathak, fixed-income fund manager)

Fiscal developments will continue to be a drag for the next six months.

The government has announced a borrowing calendar, but it seems the market does not believe the numbers.

Sees room for repo rate going below 5 per cent as most steps taken by the government are non-inflationary. Fiscal breach is not because of higher expenditure but lower revenue.

Positive on sovereign bonds because the fiscal impact is limited. Yields will head down by 30-40 basis points.

ICICI Securities Primary Dealership (Shailendra Jhingan, chief executive)

Expects the yield curve to keep steepening. Remains overweight on short-end bonds till the time the growth continues to remain weak and below potential.

As a result of the shortfall in revenues, the fiscal deficit may end up in the 3.6-3.8 per cent range. However, this does not mean large extra borrowings as the government can cut back on buybacks and increase T-bill issuance to meet some of the shortfall.

Expect 25-40 basis points of further rate cuts in the year.

Rate cuts not enough to boost liquidity-starved housing market: Poll

India's liquidity-starved economy will restrain housing market activity and price rises in coming months and into 2020, according to a Reuters poll of property market experts who were skeptical aggressive interest rate cuts will revive it.

House prices are expected to rise just 1 per cent on average this year and 2 per cent in 2020, the lowest median predictions since polling began for the two years, and well below the current 3.15 per cent rate of consumer price inflation.

A majority of respondents in the Aug. 13-27 survey said risks to those already-modest predictions were skewed more to the downside.

That comes despite the Reserve Bank of India having slashed its repo rate by 110 basis points so far this year, to 5.40 per cent. It is also expected to cut it further to 5.15 per cent over the coming months to revive a slowing economy.

However, much of that easing has not reached borrowers as banking and non-banking financial companies (NBFCs) are still grappling with very large bad loans on their balance sheets, which has led to a liquidity crunch.

The government's own assessment is that the lack of available credit is the worst in over 70 years.

"It is my expectation that we will continue to see more defaults over the next few years as developers are still facing liquidity issues due to slow sales and lack of refinancing options," said Siddhart Goel, principal consultant and founder at ARAIS Consulting.

"Even the recent rate cuts will not have a positive impact on the situation as easing by the Reserve Bank of India (is) seldom passed on by the banks to the loan seekers and never in the same quantum."

Indeed, nearly three-fourths of 18 analysts who answered an additional question said the RBI's interest rate cuts this year would have no impact on the housing market. Five said it would be stimulative and none said very stimulative.

All 18 analysts who answered a separate question unanimously said the impact of the liquidity crunch would last for at least another six months and would either be severe or very severe.

A continued deceleration in housing activity will have serious repercussions for the overall economy as the real estate market provides jobs to large swathes of people migrating from rural areas to cities looking for employment.

"The problem of low job creation looms large in India, even though the economic growth rate is predicted to be the highest," said Anuj Puri, chairman at ANAROCK property consultants.

"A stagnant formal job market has a direct impact on the sentiment of homebuyers who have to make large investments in buying a residential property. The situation will eventually improve, but not overnight."

While the Indian government has taken steps to provide stimulus to the slowing economy, analysts say those measures are too little to prop up demand significantly in the housing market, at least for now.

"Though the government has announced to help NBFCs up to first loss of 10%, it is limited to sound NBFCs and is a limited period move to help the sector sail through the crisis," said Aashish Agarwal, head of consulting services at Colliers International.

"The RBI's rate cuts are expected to lend some relief to housing market activity, but it is not expected to help usher in 'achche din' ('good days are here') for home buyers very soon, given the existing liquidity crunch in the sector."

High prices are not helping in clearing up inventories in most major cities, either.

A majority of analysts have rated both the Delhi and Mumbai markets as over-valued or extremely over-valued and predict property prices there either to drop or stay flat over the next few years.

Cities in the south of India - Bengaluru and Chennai - have been termed fairly valued and the consensus showed property prices there are expected to outperform other cities by rising between 0.25% and 3.5% over the next three years.

"End-user demand markets like Bengaluru and Chennai along with their lower floor prices are likely to see better growth with demand continuing to remain healthy backed by job creation," said Rohan Sharma, head of research at Cushman Wakefield.

"Mumbai and Delhi, with high inventory levels and delivery pressure due to lack of funding, could see muted growth."