Long-term bond yields continue to drift south notwithstanding the Reserve Bank of India's (RBI) liquidity-absorption efforts. Positive flow dynamics and the improving inflation outlook have pushed 10y bond yields to sub-8.20%, closing in on the Repo rate and at more than a year's lows, said DBS Bank in its report.
Finance Minister Arun Jaitley reiterated this week that rate cuts were necessary to low¬er the cost of capital and to boost growth. This puts the RBI in a tight bind in the run-up to the December rate review, with slippery inflation and slow 2Q FY15 (Jul- Sep) GDP growth numbers on hand. The policy tone might shift to a more neu¬tral stance, but outright rate cuts are unlikely. Unexpected commodity and food price shocks alongside the influence of base effects might be flagged as risks, as the central bank remains keen to avoid policy flip-flops.
Bond prices might briefly pare gains in the wake of the December's unchanged policy stance, with an eye also on developments in the fiscal space. In the run-up, intermittent bond sales are also likely to anchor yields and assert the central bank's anti-inflationary stance. But broader optimism on the economy’s macro prospects is likely to limit the extent of correction, it said.
On the basic balances, risks to the current account balance are minimal as lower commodity prices provide much relief to the import bill. Provided gold demand normalizes November onwards and global crude prices remain soft, the current account deficit can fall below -2% of GDP. Developments on the fiscal front however have not been encouraging, especially as tax and non-tax collections run below desired pace. The government however remains keen to stick with the fiscal deficit targets, which will necessitate further expenditure cuts in the December 2014/ March 2015 quarters, posing downside risks to our growth estimate, it added.
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