In January 2024, government securities (G-Secs) yields saw a moderation, with the 10-year G-Sec yield closing at 7.14%, a slight decrease of three basis points (bps) from December-end 2023. This decline was influenced by various factors, including consistent buying of G-Secs by foreign institutional investors (FIIs), stable domestic consumer price index (CPI), a rise market trends in oil prices, and strong economic momentum in the US.
Despite this, short-term G-Sec yields remained elevated due to tight liquidity, which further flattened the yield curve. The spreads of corporate bonds over G-Secs remained relatively unchanged during the month. The average interbank liquidity decreased month-on-month, mainly due to an increase in currency in circulation and government balances, keeping the overnight rate close to the upper end of the Reserve Bank of India’s (RBI’s) policy corridor.
Foreign portfolio investors (FPIs) continued to show interest in Indian debt, with purchases (including voluntary retention route) amounting to US$ 2.3 billion in January 2024. This marked a significant increase from December 2023 and contributed to a cumulative inflow of US$ 9.5 billion in 10MFY24. In its Interim Budget 2024-25 announced on February 1, 2024, the central government revealed fiscal deficit and market borrowing targets for FY25, which were lower than market expectations.
This led to a broad-based rally in yields. Looking ahead, the outlook for fixed income appears favorable due to several factors: Lower-than-expected budget deficit and market borrowings improve the demand-supply balance, especially with robust demand anticipated in FY25 following India’s inclusion in the JP Morgan bond index. Subdued core consumer price index (CPI) momentum, driven by lower input prices and benign global commodity prices, along with well-anchored inflation expectations. Potential easing of global central banks, particularly the US Fed, and anticipated liquidity easing and policy rate reduction by the RBI.
India’s low external sector vulnerability, supported by high foreign exchange reserves, stable oil prices, robust services exports, and expected FPI inflows into debt markets in FY25. However, there are risks to this outlook, including: High statutory liquidity ratio (SLR) holdings of the banking system and robust credit growth market trends, which may limit incremental demand for G-Secs. Potential food price shocks leading to elevated headline CPI and impacting inflation expectations. Geopolitical tensions affecting exports and oil prices.
Overall, experts anticipate yields to trade downward, with the long end likely to outperform over the medium term. While short to medium-duration debt funds remain recommended, investors may consider increasing allocation to longer-duration funds based on individual risk appetite.
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