A Snapshot of Debt Funds Market in Aug ’23

The government securities (G-Secs) yields inched up during the first half of the month, driven by a rise in US yields, resilient domestic growth, and a spike in the consumer price index (CPI). 

However, yields fell on the back of strong buying by banks and insurance sectors, and the 10-year G-Sec yield ended the month at 7.16%, down 2 basis points (bps) on a month-on-month basis. 

The other factors or events that impacted the yield movement include a rise in crude oil prices, resilient credit growth, a downgrade in the US credit rating by Fitch,  the introduction of incremental cash reserve ratio (I-CRR) by the Reserve Bank of India (RBI) to drain out liquidity, etc. The yield at the short end rose on the decline of expectations of a rate cut in the next 12  months and the introduction of I-CRR. The corporate bond spreads widened compared to July 2023. 

The average interbank liquidity declined month on month, driven by an additional 10% CRR introduced by the RBI on the increase in deposits from May 19, 2023, to July 28, 2023 (to partly blunt the impact of higher liquidity because of the recall of Rs 2,000 currency notes).  

The foreign portfolio investments (FPIs) bought (including voluntary retention route) debt worth US$ 0.6 billion in August 2023 (July 2023: US$ 0.2 billion). Cumulatively, the FPIs have bought debt worth US$ 2.7 billion in the first five months of the financial year 2024 (5MFY24) vis-à-vis being a net neutral during the same period in 2022.

The minutes of RBI’s monetary policy committee (MPC) meeting held between 6-8 August 2023 were largely in line with expectations, with most members reiterating the commitment to reaching the inflation target of 4% in due course and also taking comfort from the resilient domestic growth. 

In the past few months, the yield curve has flattened significantly as robust economic activity and above-target inflation have pushed out the expectations of rate cuts in the short term. 

The consumer price index (CPI), especially core CPI, has eased significantly from the peak and is likely to ease further in view of decelerating momentum, lower input price pressure and benign global commodity prices. 

The slowdown in services and goods exports, decline in fiscal impulse and soft private consumption will likely weigh on growth. 

Furthermore, adequate foreign exchange reserves should keep pressure on the Indian rupees at bay. It is widely expected that RBI will likely maintain pause for an extended period, and the bar for restarting the rate hike(s) is high. All the aforesaid factors bode well for the fixed-income markets. 

The sustained rise in oil prices, robust credit demand, risk of fiscal slippage and continued global monetary tightening are key risks to the outlook. The lower G-Sec demand from the insurance and provident fund (PF) sector, higher supply of state development loans (SDLs) in FY23-24, etc., could also keep the yields at elevated levels.