IIB auction: Market turmoil too strong to overwhelm valuations

Government of India to re-issue Rs. 1000 crore of 1.44% Inflation-Indexed Government Stock – 2023 on June 25

AUCTION RESULT: CUT-OFF YTM = 1.9855%

This auction comes amidst market turmoil. The latest Fed shenanigans have caused some to even wonder if this is a repeat of the asset price movement seen during late 2008. Data from China adds to worries of a mass pull out from emerging markets (Chart 1: investments by Foreign Institutional Investors in India during June-2013).  In this backdrop, finding buyers for this newly launched product is likely to be difficult.

Notwithstanding this, current valuations (@1.68% real yield) for the inflation-indexed Government security (IIB GS June-2023) could hardly be more compelling. As chart 2 shows, the IIB real yield has risen 27bp since its launch on 4th June[1]. This rise has been almost in line with the increase in the yield of the current on-the-run 10-year benchmark nominal security 7.16% G-sec 2023.

1)   The 27bp rise in the real yield could be seen as a buying opportunity. Fundamentals for the Indian economy have not changed over the last fortnight. Expectations for GDP growth continue to remain weak (if not weaker than before) and, whilst not in July, the RBI is likely to cut rates at some point during the course of the year.

2)   The Rupee has weakened more than 5% during the month of June. This move should potentially be inflationary over the medium term. However, the fact that the real bond yield has risen as much as the nominal G-sec yield (i.e. their breakeven rate has been almost unchanged) suggests that market participants have not yet priced in any inflation expectations in this market.

View: On this occasion, the Bernanke driven trend in the market looks too strong to overwhelm valuations. FIIs are least likely to participate. However, a Rs. 1000 crore auction is not big enough to weigh on the market. Cut-off estimate: 1.75%.

[1] Data from CCIL website

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