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India optimism soars as bond yields hit yearly low

Updated: Sep 25, 2023

In quest of sharing investment wisdom with our clients and prospective investors, here is our article in EconomicTimes.com Market Moguls which is an an elite platform, where the who's who of Indian financial markets blog on investment wisdom, strategies and challenges of investor interest. In this edition, we turn our attention to the remarkable surge of optimism as India's bond yields hit a yearly low, igniting ripples across the market, economy, and various sectors.


Synopsis


Indian 10-year government rates fell to a one-year low of 6.99% due to the drop in crude oil prices and the release of liquidity into the market by the RBI. The decline in bond yields is expected to benefit the economy by stimulating consumption and investment. Sectors such as real estate, infrastructure, and utilities are anticipated to gain from the lower borrowing costs. However, the Reserve Bank of India's decision to retain or lower interest rates in response to the declining bond yields is still uncertain and dependent on several factors such as inflation rate, crude oil prices, and global economic growth.


Complete Article at ET Market Moguls


In the last 12-18 months, inflation and interest rates have taken centre stage, with most market players attentive to central bankers' policy comments.


Indian 10-year government rates reached a yearly high of 7.61% in June 2022, and have since ranged between 7.11% and 7.51% until last week, when it fell to a low of 6.99% last seen in April 2022.


In the last few quarters, worldwide inflation has fallen from a high reached in the June-September 2022 period. While India, the United States, and the Eurozone have had lower inflation, the United Kingdom continues to face high inflation.


Falling petroleum prices, combined with a drop in the value of the dollar, also contributed to lower rates as the RBI purchased dollars and released liquidity into the market.


Inflation and Bond Yields:


The recent significant drop in crude oil prices is likely to keep inflation and bond yields under control. The surge in global crude oil prices has been a major contributor to India's high inflation and bond yields.


India imports almost 80% of its oil needs, making it subject to swings in oil prices. Increased oil prices raise imports, worsen the current account deficit, fuel inflation, and put pressure on the rupee.


However, crude oil prices have dropped by more than 10% in the last week due to concerns about weak demand amid weakening global demand.

This is positive for India because it will lessen inflationary pressures and budgetary stress. Lower oil prices will also support bond yields by improving market sentiment and reducing inflation expectations.


Impact on the Economy and Equity Markets:


Lower bond yields are projected to benefit the economy by stimulating consumption and investment. Growth is likely to be supported, particularly in the context of a slowing global economy.


Lower interest rates reduce the cost of borrowing for both individuals and businesses, encouraging expenditure and capital formation. This stimulates both economic growth and demand. Lower bond yields also boost government spending by lowering the government's interest burden and fiscal deficit.


Lower bond yields also make equities more appealing in comparison to bonds, as spreads narrow, making equities an attractive asset class.


Sectors to Benefit:


Certain industries, including real estate, infrastructure, and utilities, are anticipated to gain from the decline in bond yields. These industries frequently borrow extensively and are capital-intensive.


Lower borrowing costs can lead to higher earnings and stock prices. Banks can end up with treasury profits in the first quarter if yields stay low. This is due to the fact that banks have sizable holdings of government bonds, and a decrease in yields can raise the value of these bonds.


Future cash flows are discounted to determine a stock's value. High-growth stock terminal values are expected to rise in response to low risk-free rate discounting.


RBI Actions:


Bond yields have fallen, raising the possibility that the Reserve Bank of India (RBI) would hold or lower interest rates soon. However, a lot of variables will affect this choice, such as the direction of crude, the rate of inflation, potential global trade scenarios, and global as well as economic growth. But the possibilities of cuts are rising as far as the next 6-12 months are concerned.


In conclusion, the economy and equities markets are anticipated to benefit from the decline in bond yields to a one-year low.


Capital-intensive industries are likely to gain, but high-growth industries that had been hit hard are likely to recover. Consumption is predicted to gradually resume with more money in consumers' pockets because of lower inflation and anticipated lower EMI burden.


The RBI's decision to retain or lower interest rates in reaction to falling bond yields is still up in the air, so it's critical to pay close attention to economic indicators to comprehend the market's direction, which now appears to be more in favour of the bulls!



Sumit Poddar

Chief Investment Officer & Smallcase Portfolio Manager

Tikona Capital




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