Market participants indicated the central bank’s decision came as a total surprise as dealers had expected at least a 25 basis points cut in the repo rate.
The Bond market was caught unawares on Thursday when the Reserve Bank of India (RBI) decided not to cut
the repo rate in its December monetary policy following which the 10-year benchmark yield rose 15 basis points to close at a two-month high of 6.613%.
Market participants indicated the central bank’s decision came as a total surprise as dealers had expected at least a 25 basis points cut in the repo rate. It is noteworthy that the intraday high attained by the benchmark yield at 6.618% on Thursday stood very near to the closing level — a potential indication that more weakness could not be ruled out.
Vijay Sharma, senior executive vice-president at PNB Gilts, pointed out that bond yields across the curve have risen after the policy decision. “The only positive takeaway from today’s policy is that RBI has a tacit acceptance of the fact that fiscal deficit could be higher and said that fiscal and monetary sides have to work in tandem to spur growth,” Sharma said.
With inflation remaining at elevated levels and rate transmission being not up to the mark, bond market experts had earlier indicated that a possible repo rate cut in the December policy would not be of further significance. The central bank has revised its consumer price index (CPI) inflation upwards to 5.1-4.7% for the second half of fiscal 2020. With the upwards revision in CPI inflation forecast, experts believe this may be the beginning of a pause in the rate cycle. Although the pause in the rate cycle is seen as a significant step in countering the rising CPI inflation, dealers expect yields to remain at elevated levels in coming times and with no respite on the horizon.
Ananth Narayan, professor-finance at SPJIMR, said given the language adopted by the monetary policy committee (MPC) in October, the market was expecting the MPC to prioritise growth concerns and oblige with a rate cut. “However, the MPC chose to surprise with a 6-0 vote to hold policy rates. It is difficult to see a rate cut in February 2020, at a time when inflation could well be above 5%. Overall, bond yields could stay elevated, given this MPC disappointment, and given concerns around the true government and quasi-government borrowing requirements,” he said.
Murthy Nagarajan, head-fixed income at Tata Mutual Fund, indicated that the actions and response from the RBI governor seem to suggest there should be no rate cuts in the current financial year. “Next year borrowing is also expected to be above Rs 8 lakh crore and this will keep the bond yields under pressure. Further rate cuts in the next financial year may come only if GDP growth does not recover above 6 % levels,” he said.
During the monetary policy press conference, RBI governor Shaktikanta Das chose not to comment when asked about whether the central bank would follow a US Fed-style “Operation Twist” where bonds of different tenors are bought and sold according to the central bank’s objective. Experts feel that RBI may consider doing open market operation (OMO) purchases that may help keep the bond yields from hardening beyond a point.
“My sense is that with any fiscal slippage going forward, the RBI will directly or indirectly prevent the bond yields from going up and it may happen through open market operation (OMO) purchases,” Sharma of PNB Gilts said.