Yields harden as RBI holds fire for now

By: | Published: August 5, 2015 12:17 AM

The yield on government bonds rose across tenures on Tuesday after the Reserve Bank of India left key policy rates unchanged and gave little clarity on its moves in the coming months.

The yield on government bonds rose across tenures on Tuesday after the Reserve Bank of India left key policy rates unchanged and gave little clarity on its moves in the coming months.

The yield on the benchmark 10-year rose three basis points to end at the day’s high of 7.84%.

The RBI left its repo rate unchanged at 7.25% and said that it would monitor economic data and the extent of transmission of past rate cuts by banks to assess whether it has more room to cut rates.

“The policy was not as clear or even dovish as the market expected. There was no clarity on how the RBI expects transmission to take place and how banks would be able to cut base rates amid such high credit costs due to bad loans,” said Sidharth Rath, president of treasury, business banking and capital markets at Axis Bank.

The central bank noted that banks had cut base rates by around 30 bps while the cumulative reduction in the policy rate was 75 bps so far in 2015.

Yields had eased intraday after the RBI governor said that there would be periodic reviews of the investment limits of foreign institutional investors in bonds. Ever since the limits were exhausted in August 2014, market participants had been demanding an increase as the potential dollar inflow into Indian bonds was high. Given the high return that Indian bonds give vis-a-vis other emerging market bonds, FIIs have been grabbing investment limits at high premiums at every auction.

However, bonds began to be sold thereafter and yields climbed back with the 10-year benchmark ending at the day’s high of 7.84%. “The policy statement was less dovish than expected. Further, there is a demand-supply mismatch as well,” said Ananth Narayan G, Regional head of financial markets for South Asia at Standard Chartered Bank.

The RBI’s stress on gradual reduction of the Statutory Liquidity Ratio (SLR) over a period of time also weighed on the market. A reduction in SLR would reduce the incremental demand for government bonds as it would allow banks to direct deposit flow into private companies. At present, banks have to park 21.5% of their deposits into government bonds under SLR.

“There is also no consensus in the market on the RBI’s position on liquidity. Some believe that OMO bond sales would be announced as early as tomorrow,” said Narayan.

While the RBI said in its statement that easy liquidity has helped transmission of rate cuts, Rajan indicated in his interaction with market participants that the RBI may continue to withdraw liquidity through bond sales under the open market operations (OMO).

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