A Focus on Debt Market in January 2024

The government securities (G-Secs) yields moderated during January 2024, with 10-year G-Sec yield ending at 7.14%, three basis points (bps) lower than December-end 2023. 

The yield at the short end remained elevated due to tight liquidity, thus flattening the curve further. The key factors and events that influenced the fixed-income markets included consistent buying of G-Secs by foreign institutional investors (FIIs), a benign domestic consumer price index (CPI), a spike in oil prices, and strong US economic momentum. 

The corporate bond spreads over G-Sec remained largely unchanged during January 2024. 

The average interbank liquidity fell month on month, driven by a rise in currency in circulation and elevated government balances. This kept the overnight rate close to the upper end of the Reserve Bank of India’s (RBI’s) policy corridor. 

The foreign portfolio investors (FPIs) bought (including voluntary retention route) debt worth US$ 2.3 billion in January 2024 (December 2023: US$ 1.7 billion). Cumulatively, FPIs have bought debt worth US$ 9.5 billion in 10MFY24 (10MFY23: outflow of US$ 0.1 billion). 

On February 1, 2024, in its Interim Budget 2024-25, the central government announced fiscal deficit and market borrowings for FY25, which was lower than market expectations.  Furthermore, it reiterated its commitment to bring down the fiscal deficit below 4.5% by FY26. These resulted in a broad-based rally in yields. 

Looking ahead

• The outlook for fixed income remains favourable over the medium term because of the following key drivers:
• The lower-than-expected budget deficit and market borrowings are a significant positive because of improved demand-supply balance, as demand is likely to remain robust in FY25 due to India’s inclusion in the JP Morgan bond index.
• The core consumer price index (CPI) momentum remains subdued and driven by lower input price pressure and benign global commodity prices. Inflation expectations also remain well anchored and are trending lower.
• Major global central banks, especially the US Fed, have highlighted the end of the rate hiking cycle and may start easing in due course.
• The RBI is also expected to follow soon by easing liquidity and eventually reducing the policy rate in coming quarters. It will also get more confidence due to the commitment to fiscal consolidation outlined by the government.
• India’s external sector vulnerability remains low due to high foreign exchange reserves, rangebound oil prices, robust services exports, and the likelihood of FPI  inflows into the debt markets in FY25.

 However, there are the following risks to the favourable outlook. 

• The statutory liquidity ratio (SLR) holdings of the banking system are high, and credit growth is robust. With interbank liquidity in deficit, the incremental demand for G-Secs is likely to remain muted.
• Regular food price shocks can elevate the headline consumer price index (CPI) and adversely impact inflation expectations.
• The escalation of geopolitical tensions can impact exports and increase oil prices.

All in all, experts are of the view that yields are likely to trade with a downward bias, and the long end is likely to outperform over the medium term. While experts continue to recommend investments in short to medium-duration debt funds, investors could consider a higher allocation to longer-duration funds, in line with individual risk appetite.