India bonds fall; 10-year yield hits 4-month high as fiscal worries sap demand

Indian government bonds continued to decline on Tuesday after the government’s proposed tax overhaul stoked fiscal fears and sparked a market rout, pushing the 10-year yield to a more than four-month high.

The benchmark 10-year bond was at 6.5192% as of 10:50 a.m. IST, up 2 basis points from Monday’s close of 6.4968%. Earlier in the session, it hit 6.5238%, the highest level since April 9.

On Monday, the yield witnessed its biggest rise in 22 months and highest closing level since March 28.

Bond yields move inversely to prices.

On Friday, Prime Minister Narendra Modi rolled out major overhauls to the goods and services tax, which will lower prices on everyday essentials and electronics starting in October.

Government officials insist the fiscal deficit goal is still within reach, even as the plan trims a significant revenue source. Some strategists and economists also see room for the government to be able to absorb these losses. The central government could offset the revenue shortfall by utilizing compensation cess collections, the surplus marketing margins of oil marketing companies through higher excise, and through funds from select schemes, strategists at Kotak Institutional Equities said in a note. “States may have limited room to absorb SGST losses unless the centre shares gains from these measures.”

Meanwhile, traders fear that the tax-reform plan could widen federal and state budget deficit and lead to higher debt supply, dampening demand.

“We cannot rule out further selling from these levels, especially in the benchmark paper, which would see heavy supply on Friday via auction,” a trader with a state-run bank said.

RATES

India’s overnight index swap rates jumped in early trading, as rates traders continued paying while fiscal worries weighed on government bonds.

The one-year OIS rate was up 2 bps at 5.56% and the two-year OIS rate rose nearly 4 bps to 5.5350%. The liquid five-year OIS rate rose 5 bps to 5.77%.