The yield on the 10-year benchmark bond rose to an intra-day high of 6.961% on Friday after the minutes of the Reserve Bank of India’s Monetary Policy Committee (MPC) revealed the central bank’s monetary stance could turn distinctly hawkish. The yield ended the session at 6.924%, 4 basis points higher than Thursday’s close, marking a good 27-basis-point jump since the start of April. The MPC minutes revealed RBI executive director Michael Patra was of the view a pre-emptive 25-basis-point hike in the policy rate was required to prevent the need for ‘back-loaded’ policy action once inflation was already too high. “The minutes of the RBI’s 6 April policy meeting suggest that the next move will likely be a hike, as highlighted by two MPC members,” Nomura economist Sonal Varma wrote.
With long-term money becoming costlier, yields at the shorter end too have edged up substantially. The yield on the one-year Treasury bill closed Friday’s session at 6.37%, compared with its previous close of 6.35%. It has gained 26 basis points since April 3. Companies borrowing in the money markets too are paying more now. Coupons on commercial paper (CP) have been inching up and are now between 10 and 13 basis points higher than at the start of the month. Borrowers with a rating of AAA now need to pay 6.73% on the three-month instrument, compared with 6.60% on April 3.
Manish Wadhawan, managing director and head of interest rates at HSBC, said the markets had especially noted comments from one MPC member who favoured a a pre-emptive 25-basis-point rate hike. “Nobody in the market had guessed the MPC had even contemplated a rate hike,” Wadhawan said. Prasanna Patankar, managing director, STCI PD, said the sentiment was not too positive. “We expect the benchmark yield to settle at around 7.10% to 7.20% in the next couple of month as more supply kicks in and investor appetite wanes,” Patankar said. Foreign portfolio investors (FPIs) continue to buy bonds — inflows in April so far amount to $2.7 billion; in March they had shopped for bonds worth $3.99 billion. Nomura’s Varma believes food inflation would reverse as the effects of demonetisation fade and that the risks to the inflation outlook would become apparent as the favourable base effects faded.
“We believe that inflation will remain benign at sub-4% levels in Q2 but will rise sharply to 5.5-6% by Q4 2017 and in H1 2018 as cyclical factors such as a narrowing output gap, stronger rural wage growth and adverse base effects push it higher,” she observed. Bond traders have also attributed the hardening of the yields to the RBI’s move to suck out excess liquidity, estimated at around Rs 4 lakh crore. Last week, the RBI announced the auction of Rs 1 lakh crore worth of T-bills under its market stabilisation scheme (MSS). The first auction of the 329-day T-bills saw the cut-off yields at 6.38%.
“The short end of the curve moved up after the MSS auction, which in turn caused the long-term yields to rise. A 70-80 bps spread between the one-year and the 10-year yield is comfortable,” a bond trader with a private sector bank said. However, since the ceiling for gross issuance under the MSS for fiscal 2018 is Rs 1 lakh crore the central bank is expected to announce other measures, including cash management bills and open market operations (OMOs), to absorb excess liquidity.
“The RBI clearly does not want the liquidity situation to prevail. OMOs are very much a possibility now,” the trader added. The central bank left the key repo rate unchanged at 6.25% in April but raised the reverse repo rate by 25 basis points to 6% to deal with the surge in liquidity. It also trimmed the marginal standing facility rate to 6.50% from 6.75% and reiterated its neutral monetary policy stance and its medium-term target of 4% (within a band of +/- 2%) consumer price index inflation.
By Shamik Paul