Furthermore, the RBI’s decision to increase the LCR carve-out from SLR might lead to a reduced bond buying by banks in a market that is already facing issues on the demand-supply side
Bonds sold off on Wednesday after the Reserve Bank of India (RBI) hiked the repo rate by 25 basis points to 6.25%, sending the benchmark yield up nine basis points to 7.92%, to a three-year high.
Although a section of the market was anticipating a rate hike, many dealers believed any rise in rates may be pushed till the next policy. The 25 bps hike came as a surprise to many, dealers indicated.
According to Ananth Narayan, professor-finance at SPJIMR, while there are signs that the fiscal deficit may slip this year, the key to August MPC would be minimum support price (MSP), oil prices, global markets and the outlook on the fiscal front. “If MSPs are hiked more than expected in this election year, the MPC may have to further hike rates and consider changing their monetary stance,” Narayan said.
Even the inflation forecasts have raised concerns as to whether more rate hikes are in the offing in the upcoming monetary policies. The central bank has revised its inflation forecast for the second half of the fiscal to 4.7% from the 4.4% it projected in the April policy. The RBI pointed out that since the monetary policy committee’s (MPC) meeting in early April, the price of Indian basket of crude surged from $66 a barrel to $74/barrel.
“This, along with an increase in other global commodity prices and recent global financial market developments, has resulted in a firming up of input cost pressures, as also confirmed in the Reserve Bank’s IOS for manufacturing firms in Q2:2018-19. The resulting pick-up in the momentum of inflation excluding food, fuel and HRA has imparted persistence into higher CPI projections for 2018-19,” the statement said.
Sameer Narang, chief economist at Bank of Baroda, points out that there was an element of surprise in the rate action as many bond dealers were not expecting a hike in this meeting. “The market reacted, also preparing for a subsequent rate hike, perhaps in the next policy itself. Historically speaking, we have seen yields shoot up during the pre-hiking cycle or early part of the hiking cycle. In addition, there was an increase in the yields globally on Tuesday. All these together have driven the yields higher,” he said.
The RBI has cautioned that significant rise in households’ inflation expectations as gathered in the May 2018 round of survey could feed into wages and input costs in the coming months. “The staggered impact of HRA revisions by various state governments may push headline inflation up. While the statistical impact of HRA revisions will be looked through, there is a need to watch out for any second round impact on inflation,” it has said.
Furthermore, the RBI’s decision to increase the LCR carve-out from SLR might lead to a reduced bond buying by banks in a market that is already facing issues on the demand-supply side. The total carve-out from SLR now stands at 13% — indicating that a higher percentage of securities placed under SLR can be used for LCR purposes and banks won’t have to buy additional securities to maintain regulatory norms. This could be one of the reasons that might have contributed to the rise in yields, said a dealer.
Lakshmi Iyer, chief investment officer-debt at Kotak AMC, said while the rate hike was a largely discounted event, the increase of the carve-out from 11% to 13% comes as a potential demand-deterrent for government securities. “With no great triggers for yields to ease, we could expect long tenor bond yields to remain at elevated levels. Short-tenor bonds may get respite due to reduced LCR related issuance, so we could expect some easing at shorter end of the yield curve. Prudence demands to stay at shorter end of the yield curve and continue to favour accruals over duration,” Iyer said.
By: Tushar Goenka