Yields on the 10-year government bond slipped to a 16-month low on Thursday, without waiting to take cues from the central bank. The six basis points fall on Thursday was triggered by the sharp fall in crude oil prices. But yield on Government bonds has already started its downward journey some time ago. This is despite the fact that the RBI has not tweaked policy rates for a while now.

The last rate increase by the RBI was in January, after which it has kept rates unchanged. However, G-Sec yields have lost close to 80 basis points since January, most of the fall happening over the last three months. With fiscal and current account deficit worries receding and retail inflation falling, market seems to have already factored in future rate-cuts over the next year.

Narrowing spread

The RBI’s key repo rate, at which it lends to banks, is currently rules at 8 per cent. The yield on G-Sec, now at 8.08 per cent, is hovering around this rate. The last time the spread (difference between the two) was this narrow was in January 2013, when rates were expected to fall. The repo rate then was at 8 per cent, which fell to 7.25 per cent by May 2013.

According to R Sivakumar, Head — Fixed Income & Products, Axis Mutual Fund, the spread between G-Sec yields and repo rate has been 30-40 basis points in the past. In the last one year, post the liquidity tightening measure in July 2013, the spread widened. Now, the yields are trending lower indicating that the market is pricing a rate cut.

Improving macros

The attractiveness of sovereign bonds has increased with the improvement in the fiscal and current account deficits.

“We are not dependent on the RBI’s rate cut alone. Structurally, there is reason for us to be positive on rates,” says Suyash Choudhary, Head — Fixed Income, IDFC MF.

“Till last year, funds supply fell short of demand and, hence, there was a case for higher interest rates. One of the indicators was the banks’ credit to deposit ratio that peaked last year, even when the economy was growing only at about 5 per cent. Another was the $88-billion current account deficit in 2012-13,” says Suyash.

Changing scenario

Now, the scenario has changed. “Deposit growth is exceeding credit growth. The $30-billion current account deficit for this year can be funded by the flows through FDI alone. The RBI’s concern of foreign flows being impacted following a rate hike in the US, should also start receding,” he adds.

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