Sunday, April 5, 2009

>India Watch (HSBC)

Bond market: RBI to the rescue?

■ RBI quantitative easing measures to provide support to Government of India (GOI) issuance

■ However, GOI issuance could still surprise on the upside, keeping upward pressure on GOI yields

The RBI on 26 March unveiled the first half of fiscal year 2010 GOI issuance program and various Quantitative Easing measures (QE) to facilitate a smooth absorption of this issuance. During H1FY10, RBI intends to provide further liquidity to the system in the form of Market Stabilisation Securities (MSS), buybacks (INR420bn) and Open Market Operation (OMO) purchases of government securities (INR800bn). The latter amount is equal to about 33% of scheduled gross issuance of INR2,410bn and 57% of gross issuance minus bond redemptions (INR330.89) and coupon payments (INR679.24bn). During Q1FY10, MSS buybacks and OMOs will total INR375bn and INR400bn, respectively, with OMOs equalling 27% of gross issuance. Moreover, the RBI stated that it will be more consistent in its OMO operations (every alternate week on Thursday) and provide INR200bn in Ways and Means Advances to the government.

The RBI's QE announcements will provide some comfort near-term to the market, which had been looking for RBI OMOs to absorb at least 50% of GOI issuance. That said, risks of further fiscal slippage and disappointments on the supply front cannot be ruled out, certainly as the H1FY10 GOI issuance schedule contains a relatively high share of longdated issuance (68% of issuance is 10 years and longer). Official announcements that total FY10 issuance will amount to INR3.6tr correspond with the government's deficit target of 5.5% of GDP. However, our house view is for a 7% fiscal deficit, or INR4.6tr of total gross GOI issuance. Moreover, gross GOI issuance could be augmented further once RBI decides to convert INR328bn of additional T-bill issuance during FY09 into GOI bonds.

Given this backdrop, GOI yields may remain elevated over the next few weeks, also responding to the traditional tightening of liquidity in the run-up to the May general election, the election-related uncertainties and poor investor demand and liquidity in the secondary market. That said, according to our regression model, the fair value range for the 10yr GOI yield is 5-7.25%, assuming a 4% 10yr US Treasury yield by year-end. The range drops to 4.2-6.5% based on a 2.5% US Treasury yield and a further cut in the RBI reverse repo rate to 3% at the April quarterly MPC meeting. In turn, we recommend accumulating GOIs at yields of 7.25% or higher in tenors up to 10 years.

To see full report: INDIA WATCH