RBI steps to keep lid on yields, equity markets likely to be cautious on geopolitical tensions

The Indian Express
Dated September 01, 2020

A record contraction of 23.9 per cent in Gross Domestic Product (GDP) in April-June quarter is unlikely to cause disruption in the bond market as measures announced by the Reserve Bank of India (RBI) on Monday will provide a fresh impetus to buying activity while keeping a lid on yields. Equity markets, which are being driven largely by global liquidity and expectations of normalcy returning to the markets, may remain cautious after sharp falls on Monday, following news of Chinese aggression at the Indian borders, market analysts said.
The decline in nominal GDP growth rate, however, is expected to push up the fiscal deficit for the year. According to a report by Care Ratings, while the nominal GDP growth fell to record lows of -22.6 per cent in Q1 2020-21, as against growth of 8.1 per cent in Q1 2019-20, since it indicated lower revenues for the government it has adverse implications for the fiscal deficit ratio. “The severe contraction in nominal GDP will push up the fiscal deficit ratio (as a percentage of GDP) for the year. The fiscal deficit Budget target of 3.5 per cent for the current fiscal year is based on the assumption of 10 per cent growth in GDP,” said the report.
DK Joshi, chief economist at Crisil, said while fiscal deficit will depend on the full-year GDP, the numbers show that the revenue position of the government in this quarter would have been very tight and fiscal stress would have been high.
From a low of 5.74 per cent on July 10, yield on the 10-year benchmark government bond rose to 6.23 per cent on August 24, but fell subsequently to 6.08 per cent on Monday, as liquidity measures announced by the RBI in the bond market assured investors that the elevated borrowing programme of the government will go through smoothly this year. Yield and bond prices move inversely, with higher yields pushing down bond prices and vice versa — making it difficult for the government to raise funds at cost-effective rates.
“Even though RBI does not take a view on yields, or tries to maintain any particular level, we do expect that there wouldn’t be any undue disruption in the market. Monday’s action (of the RBI) should provide comfort to the market, despite the slump in economic activity,” a senior government official said. Despite record contraction in GDP and expectations of government borrowing heavily in bond markets, the Finance Ministry expects yields to remain “soft”, sources said.
“With GDP numbers expected to remain weak in second quarter, inflation expected to decline and accommodative stance from RBI, the bond yields are expected to remain soft in immediately future,” said LIC Mutual Fund CEO Dinesh Pangtey. The RBI on Monday said in support of the accommodative stance of monetary policy, it is committed to ensuring comfortable liquidity and financing conditions in the economy. It announced an increase in the ratio of securities that banks can hold till maturity within their statutory liquidity ratio (SLR) requirement. This would help banks in containing mark to market losses on their bond portfolio. The central bank also announced open market operations and a Rs 1-lakh crore worth of liquidity injection (term repo operation) measures in mid-September to maintain orderly conditions in the market.
“GDP data is on an expected line, now the market will look for GDP recovery in the remaining months of FY21, however, this is not strong enough to offset the shock from Q1. Base effect will push up growth in FY22. Now, watch out will be, after unlock 4.0, how the economic activities pans out and the direction of the high frequency indicators,” said Naveen Kulkarni, chief investment officer, Axis Securities.
Analysts note that while GDP contraction was expected by the financial markets, for the equity segment, other factors will come into play.”What is more concerning for the equity markets is the latest tension brewing on the India China border and also the new margin requirement for the retail investor, which requires the investor to put upfront 20 per cent margin in form of cash or stock for both buy or sell. The Q1FY21 GDP print is already priced in the markets. What needs to be looked at is the Q2FY21 GDP no. If that no. is also on the negative side and on similar lines to Q1FY21 GDP print, then we may see a correction. The current rally and euphoria has been on back of liquidity injected globally and in India. I will continue to be cautious,” said Arjun Yash Mahajan, head–institutional business, Reliance Securities.

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