Mumbai: Bond traders in India are facing the most turbulent times in almost three years as the central bank grapples with the gush of funds flowing into the financial system following the government’s surprise currency ban.
Prime Minister Narendra Modi’s November 8 decision to withdraw about 86 per cent of the currency in circulation flooded lenders with cash as people rushed to submit the old bills, sending benchmark bond yields to seven-year lows on bets banks will use some of the funds to buy bonds. Meanwhile, concern excess money supply will fan inflation and threaten financial stability saw the central bank take extraordinary measures to drain liquidity, hurting the debt rally.
With the rupee plunging to a record low last week amid foreign outflows from bonds, a gauge of historical volatility for Indian sovereign notes due in a decade has more than doubled since the end of last month to reach the highest level since January 2014. The Reserve Bank of India told lenders to set aside more deposits as reserves in a statement on Saturday, adding that it will review the step in two weeks time. It then added about Rs3.3 trillion (Dh177.4 billion, $48.1 billion) via repurchase agreements on Monday.
“It’s been quite a roller-coaster ride for bonds, a new day everyday as you don’t know what to expect,” said Killol Pandya, Mumbai-based head of fixed income at Peerless Funds Management Co., which oversees about Rs9.7 billion. “We are hearing that other cash-control measures are also coming and markets are going to react to everything now. Volatility will stay for some time.”
Foreign holdings of Indian government and corporate debt have dropped by Rs140 billion rupees this month, set for the biggest decline since October 2013, National Securities Depository Ltd data compiled by Bloomberg show. The outflows have come amid an emerging-market sell-off triggered by rising odds for a US interest-rate increase next month.
The 30-day historical volatility for India’s benchmark 10-year bonds has jumped to 14.7 per cent from 7 per cent at the end of October. The yield on the securities fell one basis point to 6.32 per cent in Mumbai on Tuesday, after climbing nine basis points on Monday in its biggest increase since August 2015. It is down 47 basis points this month and set for the steepest decline since May 2013.
November’s rally in bonds has also been supported by expectations that policymakers will lower benchmark interest rates at the December 7 monetary review. Consumer prices rose 4.20 per cent in October from a year earlier, the smallest pace of increases since August 2015.
“The 10-year bond is expected to remain volatile in the coming months as clarity on the impact of demonetisation and subsequent RBI and government steps is reached,” ICICI Bank Ltd analysts, led by Niharika Tripathi, wrote in research note dated November 28. “We maintain our call and expect the RBI to deliver at least a 25-basis point rate cut in December. However, a deeper rate cut cannot be ruled out.”
The rupee rose 0.2 per cent to 68.6550 per dollar.