Indian debt markets - a perspective

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: Reserve Bank of India (RBI) stepped up its efforts to tame inflation by increasing both repo rate and Cash Reserve Ratio (CRR) by 50 bps each. The latest move is a reflection of the reversal in interest rate expectations in 2008.With domestic inflation under control and slowdown in industrial production, markets were expecting monetary easing at the start of the year. However, a sharp rise in headline inflation numbers changed the interest rate environment dramatically.

Global

Central banks in developed economies cut interest rates and undertook liquidity infusion to ease the impact of the credit crisis earlier in the year. However, persistent rise in crude oil prices and commodities has resulted in a difficult scenario with inflationary pressures building up and economic growth decelerating. This has resulted in central banks’ primary concerns shifting from growth to inflation risks, reflected in the recent comments from US Federal Reserve and European Central Bank.

Unlike developed countries, economies in the Asian and Emerging Markets space have consistently adopted a tight monetary stance to deal with rising inflation due to commodity and food prices, on the back of relatively higher economic growth.

Central banks in countries such as China, South Korea, Brazil, Mexico, South Africa, have been raising interest rates.

There is no clarity if we have witnessed the peak in terms of commodity prices, but the high prices have led to political chatter about preventing investors/speculators from investing in commodity markets.

Policy statements out of US and Europe will be closely watched by investors to understand if there is a shift in monetary policy towards status quo or tightening. The developments in the financial sector will also be important, given the implications for the credit markets.

India

The economy had witnessed a period of sustained high growth rate for the past few years and relatively lower inflation, helped by pre-emptive actions taken by RBI. It had withstood the rise in oil and commodity prices relatively well helped by strong growth and the absence of full pass through of global energy prices. However, sustained domestic demand and rising imported inflation have led to a sharp rise in headline inflation numbers since March, leading to a slew of fiscal and monetary measures. This had culminated in the multi-year high inflation growth numbers released last week and RBI’s 50 bps hike in CRR and repo rates this week. Consequently, yields have moved up sharply across the curve.