INDIA’S sovereign bond yields are likely to head sideways in coming months before starting to spike higher toward yearend, according to a 25-year bond-market veteran.

Signs of quicker inflation and concern the Reserve Bank of India (RBI) will pull back on policy support should eventually put yields on a rising path, said Radhavi Deshpande, chief investment officer at Kotak Mahindra Life Insurance Co. in Mumbai. Consumer prices will start to rise as the virus wave subsides, and that will also convince policy makers to ease back on stimulus, she said.

“We expect the benchmark 10-year yield to head toward 6.50% as inflation worries and policy normalization concerns begin to resurface along with reducing support from the RBI as we approach the year end,” she said in an interview. Yields may stretch toward the high, last seen in April 2020, by March, she added.

The first steps toward policy normalization at the RBI can be expected in December with policy makers likely to raise the reverse repo rate and start draining liquidity through variable reverse repos of different tenors, Deshpande said. The benchmark yield was at 6% on Monday.

India’s move toward higher bond yields and interest rates will be another milestone in the recovery of global financial markets from the ravages of the coronavirus. Progress toward normalization in the South Asian nation has seen a massive setback in recent months as the nation suffered one of the world’s worst outbreaks of the pandemic.

While there have been signs in recent weeks that the current virus wave is easing, inflation is likely to stay in a range of 4% to 6% over the next nine-to-12 months, said Ms. Deshpande, who was previously head of proprietary trading at Kotak Mahindra Bank Ltd. Still, demand should start to recover as the number of cases falls and that will help stoke inflationary pressures, she said.

DEBT PURCHASES
Inflation data in recent months have been mixed. The consumer price index fell to 4.3% in April, the second-lowest level in more than a year, driven down by cooling food and beverage prices. In contrast, wholesale-price inflation jumped to the fastest pace in more than a decade in the same month amid climbing commodity prices and a low base from a year earlier.

Concern about potential inflationary pressure has made the RBI unwilling to cut interest rates further. The central bank has instead chosen to pump extra liquidity into the financial system and buy bonds to cap yields. The central bank has said it will purchase 1 trillion rupees ($13.8 billion) of debt this quarter in addition to its existing Operation Twist programs and open-market debt purchases.

The RBI will need to step in with about 4 trillion rupees of bond purchases in total to meet the demand-supply imbalance in government bonds, she said. At some point though, it will have to wind back its emergency pandemic measures, paving the way for yields to rise.

“Once economic growth and hence credit picks up pace we should see a natural shift in demand away from sovereigns,” which will help push yields higher, Ms. Deshpande said. — Bloomberg

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