Bonds recovered on Wednesday after the Reserve Bank of India (RBI) in its sixth bi-monthly monetary policy decided not to hike the repo rate and sounded less hawkish than market expectations, in an environment where inflationary concerns have remained to the fore. The 10-year benchmark yield closed four basis points down at 7.53% on Wednesday, after hitting an intraday high of 7.61%. The yield on the old benchmark bond—6.79% yielding notes maturing in 2027—fell 5 basis points to end the session at 7.69%, after rising as high as 7.80% during intra-day trade. The central bank continued to maintain its “neutral stance” and stated that consumer price index (CPI) inflation for 2018-19 is estimated in the range of 5.1-5.6% in the first half, including diminishing statistical house rent allowance (HRA) impact of central government employees, and 4.5-4.6% in the second half, with risks tilted to the upside. MS Gopikrishnan, head of FXRC trading, South Asia at Standard Chartered Bank, observed that a higher inflation estimate by RBI coupled with no change in repo rate has been taken positively by the market.
“The tone of the policy was hawkish; if not, the fall in yields would have been more pronounced viz. by 15-20 bps. The fact that the central bank has given a higher inflation estimate than their target of 4% and has held to the policy rate, has led to a perception that they won’t tinker with rates if inflation remained within those levels. The RBI has stated it would watch the incoming data closely and it looks like the central bank would be comfortable with the average CPI inflation remaining close to 5% (without adjusting for HRA component),” he stated. A variety of factors like rising crude prices, surging US Treasury yields, higher inflation, fears of fiscal slippage and demand-supply dynamics in the central government securities market have pushed the yield on the old benchmark higher by 66 basis points since the previous policy in December. In the two months since the last monetary policy was declared, the 10-year US Treasury yield has risen by 44 basis points while Brent Crude price has surged by $5.6/barrel.
During Wednesday’s announcements, the RBI acknowledged inflationary uncertainties like HRA increases by state governments, impact of global growth on domestic inflation, rise in minimum support prices (MSP) and fiscal slippage. However, it has also taken into account some mitigating factors. “First, capacity utilisation remains subdued. Second, oil prices have moved both ways in the recent period and can potentially soften from current levels based on production response. Third, rural real wage growth is moderate,” the policy document stated. Ananth Narayan, professor-finance at SPJIMR points out that the RBI came out with what the market was anticipating—no rate hike, neutral stance but pointing out macro and inflation risks and this was taken positively by the bond markets. “While the tone was hawkish in pointing out the risks, the projections on expected inflation — average 5.1% for this quarter, 5.1-5.6% for H1 FY19, and 4.5-4.6% for H2 FY19 indicate the RBI will look through spikes in inflation. The projections given by RBI are very reasonable, and will only be breached if additional data comes in — say a further spike in the price of oil. As a base case, we should be within the inflation glide path of RBI, and therefore may not see any immediate rate hikes,” he said.