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The bond market was widely expecting a 25bps hike in repo rate and was divided on a 25bps hike in the cash reserve ratio.
The bigger-than-expected rate hikes caused a sell-off in bonds with the benchmark ten-year gilt yield rising from 9.05% levels pre-policy to 9.45% levels post policy.
By raising interest rates and keeping liquidity tight, the central bank is expected to control strong aggregate demand conditions in the economy and bring down money supply growth to 17% levels from 20%-plus now.
The cost of fighting inflation is economic growth, and RBI has revised GDP growth estimates from 8% -8.5% to 8% for 2008-09.
The actions will keep liquidity tight and cost of accessing liquidity from the RBI will be high with the repo rates at 9%.
This will keep the short end of the curve under pressure.
The longer ends will move on demand and supply, with supply coming in from government bond auctions, while demand will be a determinant of interest rate outlook.
The yield curve, however, will be flat to inverted at the one-over-ten segmentas short-
end rates will be hovering around 9.5% levels on the back of tight liquidity, while ten-year benchmark bonds will set a trading range of 9.40% to 9.60%.
Corporate bond yield curve will also be similar to that of government bonds with the curve inverting on increased supply at the short end as issuers would prefer to have short-duration liabilities, expecting rates to fall over the longer term.
The longer ends will see demand from provident funds and insurance companies given their nature of liabilities and this demand will tend to keep yields sticky at higher levels.
The outlook for interest rates in the near term will remain uncertain given that RBI is in an inflation-fighting mode and inflation is expected to be in double digits for close to the end of calendar 2008.
Oil will remain interest rate negative until prices come off from current levels of $125bbl to close to $100bbl.
Oil prices have come off significantly from levels of $145 to $125 a barrel, but RBI would rather work on the assumption that oil prices will remain high.
The case for oil prices coming off is demand tapering off on account of growth slowing
down across the globe.
In the medium to long term if RBI actions bear fruit with inflation coming off and growth tapering down, then the case for interest rates to come off is strong as RBI can relax its inflation fighting policy stance.
Please add disclaimer: "The author is senior fund manager - fixed income, IDFC Mutual Fund and views are personal"
