The unexpected policy rate hike by the Reserve Bank of India (RBI) on Friday has spooked bond markets. Instead of falling due to relaxations in liquidity norms, the bond yields have been rising.
The yield on the 10-year benchmark government bond, which had softened from near 9% levels, jumped to an over-three-week high of 8.85% on Monday, up 27 basis points (bps) from the close on Friday and 66 bps from Thursday.
“Markets feel that rates may go up again,” said the treasury head at a large public sector bank.
RBI hiked the repo rate by 25 bps to 7.5% in the mid-quarter monetary policy review on Friday, contrary to the market’s expectation of a status quo and even a rate cut as and when the rupee stabilised.
The apex bank said that controlling inflation was important and a rate hike was necessary to anchor inflationary expectations.
After falling to a 43-month low of 4.8 in May, headline inflation, as measured by the wholesale price index (WPI), started rising in June due to the impact of a depreciating rupee.
RBI governor Raghuram Rajan was of the view that the need to anchor inflation and inflation expectations had to be set against the fragile state of the industrial sector and urban demand.
In order to ease liquidity conditions, the RBI had cut the marginal standing facility rate by 75 bps to 9.5% and indicated that the rate could see more reductions going forward. Also, the daily requirement of cash reserve ratio was brought down from 99% to 95%, a move that bankers did not find to be of much help.
Market participants said there is a need for liquidity infusion by way of open market operations (OMOs).
“There will be a similar movement on Tuesday if the RBI does not announce OMOs,” said Jayesh Mehta, managing director and country treasurer at Bank of America Merrill Lynch in India.
The government bond auction on Monday saw about Rs4,000 crore of devolvement on primary dealers. The RBI had auctioned four government securities of Rs15,000 crore that saw cut-off yields between 8.78% and 9.25%, depending on the maturity.
Tirthankar Patnaik, India strategist and chief economist at Religare Capital Markets, said the devolvement underlined the demand for yield in a market shocked by Friday’s rate hike and expecting more to come.
Bond yields are expected to rule high going forward despite the government sticking to its market borrowing plan as budgeted.
On Monday, the government said it would raise Rs2.35 lakh crore in October-March period this financial year. The average weekly borrowing would be Rs15,000 crore. This is in line with the roadmap of raising Rs5.79 lakh crore in the current financial year. Additionally, the government would consider replacing Rs50,000 crore of shorter dated securities with longer dated ones in the market.
Yield on 10-year benchmark bond at over-three-week high of
8.85%, up 27 bps from the close on Friday.
The yield had closed Wednesday at 8.19%, down from as much as 9% earlier.
Market participants say there is a need for liquidity infusion through open market operations by the central bank.