Bond yields set to rise on hard talk

Written by Aparna Iyer | Mumbai | Updated: May 4 2013, 05:57am hrs
Traders were expecting rate cut to be accompanied by dovish statement & greater emphasis on growth

In the wake of a hawkish monetary policy stance by the Reserve Bank of India (RBI) and heavy supply ahead, government bond yields could rise with the 10-year benchmark bond expected to touch 7.85% in the next four weeks.

The yield on the benchmark 10-year 8.15%, 2022, bond rose 6 bps to 7.78% on Friday. In its annual policy statement for 2013-14, RBI cut the repo rate by an expected 25 bps to 7.25%, but said that there is little room for more rate cuts.

Further, the RBI indicated that there could be a reversal in stance if the risk from the current account deficit increases.

I think the initial reaction was because of the indication of a reversal, said Hitendra Dave, head of global markets-India at HSBC.

Bond market participants had expected the rate cut to be accompanied by a dovish statement and a greater emphasis on growth by the central bank. The fall in WPI inflation, coupled with the ease in global commodity prices, had strengthened expectations that the RBI would sound dovish at the policy. This had led to a fall of nearly 30 bps in bond yields in the last one month.

Dave expects the 10-year bond yield to rise by 5-10 bps because of the supply through auctions under the government borrowing plan.

The government will raise close to R75,000 crore from the bond market in May.

With the policy outcome now behind them, bond dealers said that economic data will be key. One will have to watch data very closely now to determine further action, said Shilpa Kumar, head of global markets, ICICI Bank.

Demand for bonds will be hit more as banks have less incentive to buy them now after the cut in the proportion of bonds to be kept in held-to-maturity category to 23% from 25%. However, since the cut in the HTM investment will be spread over four quarters with 50 bps taking effect every quarter, the immediate impact on yields would be limited, bond dealers said. Also, with the cut in HTM, banks will have to mark-to-market a bigger part of their bond portfolio. There wont be much impact from the HTM cut as it is spread over quarters and has been long expected by the market, said Dave.