Kotak MF sees India's bond yields confined in tighter ranges

A man walks past the Kotak Mahindra Bank branch in New Delhi

By Dharamraj Lalit Dhutia

MUMBAI (Reuters) - Falling global oil prices and tempering inflation levels will keep Indian bond yields in tighter ranges and cause longer term yields to compress further, says Kotak Mahindra Asset Management Company.

Lakshmi Iyer, chief investment officer for debt and head products at Kotak expects the benchmark bond yield to trade in a range of 10-15 basis points from its current levels, tighter than the 22-25 bps range in June and July.

She also expects the yield on the new 10-year bond being auctioned this week to be 5-6 basis points lower than prevailing rates. Ten-year yields were around 7.24% on Thursday.

"Oil has been a saving grace no doubt in the recent past. The key trigger is the direction of oil prices – as our sensitivity to this commodity is among the highest," Iyer said.

India is due to sell bonds worth 330 billion rupees ($4.14 billion) on Friday which includes 130 billion rupees of a new 10-year bond that will replace the existing benchmark note in coming weeks. Traders expect strong demand for the note.

Global oil prices have eased recently, with the benchmark Brent crude down nearly 15% in August to six-month low, amid concerns over demand and possible recession.

Falling oil prices have improved the local inflation outlook as India is a major importer of the commodity. Retail inflation dipped to 6.71% in July, easing for the third month.

Despite this softening of oil prices and recent easing in inflation, Iyer expects the Reserve Bank of India to hike repo rates further.

"Looking at the RBI forecast for CPI at 5.80% in Q4 FY23, there is a case to further effect hike in benchmark rates. We expect FY23-end repo rate to be in the vicinity of 5.90%-6.00%," Iyer said.

The RBI has hiked key policy rate by an aggregate of 140 basis points in three meetings since May, but inflation continues to remain above its tolerance band at 200 basis points on either side of 4%.

The fund manager feels market fears of additional government borrowing are unfounded and prefers four-year to seven-year bonds as the "yield curve has flattened considerably."

Iyer also expects moves in the local currency to impact bond yields. The Indian rupee has fallen 0.5% so far in August, after falling for seven consecutive months in 2022. It was at 79.68 against the dollar.

($1 = 79.6480 Indian rupees)

(Reporting by Dharamraj Lalit Dhutia; Editing by Vidya Ranganathan)