INR bonds eye liquidity support; Bond flows in Malaysia and China set to improve

INR bonds eye liquidity support; Bond flows in Malaysia and China set to improve
Radhika Rao, Duncan Tan15 May 2019
    Photo credit: AFP Photo

    India rates: INR bonds eye liquidity support

    INR 10Y sovereign bond yields were flat in the past week, before easing yesterday owing to a supportive inflation print and hopes over liquidity support. Generic 10Y yields eased to the weaker end of 7.35%-7.4%, while the 2028 paper oscillated around 7.5%. From an elevated 6.8% in late-April, 2Y yields eased to sub-6.7%, as below-target inflation spurred expectations for further cuts. A benign inflation trend and weak growth outlook provide enough justification for the RBI to stay on an accommodative path. The timing, however, is a matter of debate (see here). The global risk environment is also an important factor in the mix, with an escalation in US-China trade tensions already weakening the rupee by over 1% last week, hurting any imbedded currency interests amongst foreign portfolio interests. Rather than trade links, India is vulnerable to any escalation in the trade war through capital outflows owing to weak market sentiments.

    Despite an accommodative monetary policy, tight liquidity has limited any respite to corporate borrowing costs. Demand for the longer-end of the curve remains subdued, as reflected in the scrapping of an INR bond by a regular issuer, while another was issued at a premium. Lingering concerns over the health of erstwhile fast-growing NBFCs is also a source of concern, just as the oil price direction is being watched closely.

    Providing calm at the margin are expectations that the RBI will address this squeeze after the elections, with a mix of OMOs, FX swaps and other regular operations. The second tranche of INR125bn worth bond buybacks will be held on May 16. Passage of elections will also lower the government’s cash surplus with the central bank (averaged INR500bn this month) as spending resumes, improving liquidity, along with slower currency in circulation. These might provide a window for borrowing costs to ease between June to August, before supply worries reassert themselves. For now, we expect the long-end of the yield curve to stay supported, while rate cut expectations reflect better in the short-to-the belly of the curve.

    Asia rates: April's foreign bond flows

    April's foreign flow numbers for Asian government bonds had two notable entries. Malaysian government bonds recorded sizable outflows of USD2.0bn, fully reversing the strong inflows printed in February and March. The outflows were driven by concerns over the potential market impact of two technical events, namely the expected removal of Malaysian bonds from Norway sovereign wealth fund's benchmark index, and possible exclusion from FTSE Russell's WGBI index (see here). Thus far in May, the market backdrop has improved. The ringgit has stabilized (forwards are no longer pricing for volatility) and Malaysian bonds have fully recovered from April's selloff (locals could have stepped in to support). Therefore, barring any negative news relating to FTSE Russell's September decision, we expect outflows to moderate ahead.

    Inflows into China government bonds in April (USD2.8bn) were somewhat underwhelming amid their addition to Bloomberg's BBGA index on April 1. We had estimated index inflows to be around USD2.4-3.0bn and non-index flows to be at least USD2.0bn. We suspect some of the non-index buyers could had stayed away in April because bond yields were climbing (10Y up 33bps) on the back of pick-up in economic data, rally in Chinese equities and some signs that PBOC was looking to pull back on stimulus. Actual index flows could also had been smaller because some firm were not yet operationally ready to trade China bonds. With resumption of US-China trade hostilities in May, PBOC is expected to retain a supportive stance to cushion the impact (RRR cut has already been announced for small and mid-sized banks). Coupled with large draw-downs in Chinese equities, bonds are likely to outperform and thus, foreign inflows should accelerate ahead.

    We think Korean government bonds could offer good broad protection against escalations in global trade disputes (beyond US-China). Korea has strong trade/economic linkages with China. Its bonds are highly sensitive to global growth/demand outlook and market volatility. Recall in 2018, Korean bonds, together with China bonds, were huge beneficiaries of elevated US-China trade hostilities. We want to point out that there are considerable risks around CNY (spread between spot and fixing has widened sharply) and KRW (down 4.6% in one month as more headwinds gather). Thus, investors may want to hedge out FX exposure.

    Radhika Rao

    Economist – India, Thailand & Eurozone

    Duncan Tan

    FX and Rates Strategist - Asean

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