Off late bond markets have seen some volatility with yields going down in expectation of lower inflation and rate cuts and then moving up because of FIIs withdrawing some money from the bond markets.
Yields are still lower than what they were a year back, only off the lows they made recently.
Rupee depreciation majorly caused by this FII withdrawal from the debt market has made it difficult for RBI to cut rates further and yields may have already incorporated that reality.
So now where do we go from here?
Inflation has been coming down last few months, rate cuts from RBI have followed, though not from the banks to the same extent. Finance Minister and Planning Commission have been cajoling the banks into cutting rates further to give a boost to the economy.
I have written before on why I think high, not low, inflation is the way out of the mess that the economy is in. Please find those views here:
High Inflation - Way out??
In fact, I would be tempted to go ahead and bet that markets will force high inflation on us, how much ever we would want it to go the other way.
Have a look at what happened in the bond market.
Govt and RBI opened up to the FIIs in the bond market to cover the huge Current Account Deficit (CAD).The high yields in the Indian market did attract FIIs and they ended up owning 38 bn USD of Indian bonds by May 2013.
The bonds then rallied and yields went down by almost 100 bps. Thus FIIs were sitting on profits.
But at the same time, because of the lower yields, it was not as attractive for FIIs to put incremental money, particularly the hedged arbitrage money. Thus started the initial outflow of dollars from the bonds and it had the corresponding impact on the currency.Currency depreciation started eating away gains and led to more outflows and we had a full fledged depreciating run on the currency.
This round of currency depreciation has caused worries that the lowering trend in inflation might be ending. If that comes out true, in effect, markets would have forced inflation on us through the currency.
What happened in the bond markets and its after effects on currency were nothing but payback for the borrowing binge we have had for the last 3-4 years.
Lets have a look at government finances.
I am jumping the gun as its early in the fiscal year, but if the early trends in the first two months are any indication of what is coming on the revenue collection for the year, then govt is very likely to overshoot its fiscal deficit target by some margin.That is likely to be inflationary if they continue their spending ways in an election year.
As I have mentioned in the previous article, linked above, govt itself needs high inflation to meet its revenue targets not only for this fiscal year but for the whole 5 year plan as well.
Overleveraged corporates can repay banks only if there is product price inflation which enables them to make that extra buck.If that doesnt happen the stock markets are not going to be kind. FIIs may withdraw money from there as well. In any case Indian markets have not exactly set the stage on fire with their dollar returns for the FIIs. That may lead to further depreciation and implied higher prices and inflation.
Net net....I think we need high inflation and markets are going to force that on us.
If that happens can the 10 year govt bond keep yielding 7.5-7.6%??
This is a volatile world and surely I can end up looking completely idiotic making these conclusions. There are so many factors like the crude oil prices, QE in US etc which can change the way things are looked at.
But with all that as the background, I would still bet that there is a reasonable probability, more than 50%, that the 10 year govt bond might be yielding more like 8.5-9% in the next one year.
I also think that these higher rates are not going to have any meaningful impact on GDP growth, because that in case may not be much beyond 5%,in my opinion.
Low growth and high inflation might be here to stay for some time...!!
(Standard Disclaimer : The probability of my opinions going horribly wrong is closer to 1 than zero!!)
Yields are still lower than what they were a year back, only off the lows they made recently.
Rupee depreciation majorly caused by this FII withdrawal from the debt market has made it difficult for RBI to cut rates further and yields may have already incorporated that reality.
So now where do we go from here?
Inflation has been coming down last few months, rate cuts from RBI have followed, though not from the banks to the same extent. Finance Minister and Planning Commission have been cajoling the banks into cutting rates further to give a boost to the economy.
I have written before on why I think high, not low, inflation is the way out of the mess that the economy is in. Please find those views here:
High Inflation - Way out??
In fact, I would be tempted to go ahead and bet that markets will force high inflation on us, how much ever we would want it to go the other way.
Have a look at what happened in the bond market.
Govt and RBI opened up to the FIIs in the bond market to cover the huge Current Account Deficit (CAD).The high yields in the Indian market did attract FIIs and they ended up owning 38 bn USD of Indian bonds by May 2013.
The bonds then rallied and yields went down by almost 100 bps. Thus FIIs were sitting on profits.
But at the same time, because of the lower yields, it was not as attractive for FIIs to put incremental money, particularly the hedged arbitrage money. Thus started the initial outflow of dollars from the bonds and it had the corresponding impact on the currency.Currency depreciation started eating away gains and led to more outflows and we had a full fledged depreciating run on the currency.
This round of currency depreciation has caused worries that the lowering trend in inflation might be ending. If that comes out true, in effect, markets would have forced inflation on us through the currency.
What happened in the bond markets and its after effects on currency were nothing but payback for the borrowing binge we have had for the last 3-4 years.
Lets have a look at government finances.
I am jumping the gun as its early in the fiscal year, but if the early trends in the first two months are any indication of what is coming on the revenue collection for the year, then govt is very likely to overshoot its fiscal deficit target by some margin.That is likely to be inflationary if they continue their spending ways in an election year.
As I have mentioned in the previous article, linked above, govt itself needs high inflation to meet its revenue targets not only for this fiscal year but for the whole 5 year plan as well.
Overleveraged corporates can repay banks only if there is product price inflation which enables them to make that extra buck.If that doesnt happen the stock markets are not going to be kind. FIIs may withdraw money from there as well. In any case Indian markets have not exactly set the stage on fire with their dollar returns for the FIIs. That may lead to further depreciation and implied higher prices and inflation.
Net net....I think we need high inflation and markets are going to force that on us.
If that happens can the 10 year govt bond keep yielding 7.5-7.6%??
This is a volatile world and surely I can end up looking completely idiotic making these conclusions. There are so many factors like the crude oil prices, QE in US etc which can change the way things are looked at.
But with all that as the background, I would still bet that there is a reasonable probability, more than 50%, that the 10 year govt bond might be yielding more like 8.5-9% in the next one year.
I also think that these higher rates are not going to have any meaningful impact on GDP growth, because that in case may not be much beyond 5%,in my opinion.
Low growth and high inflation might be here to stay for some time...!!
(Standard Disclaimer : The probability of my opinions going horribly wrong is closer to 1 than zero!!)
