Mumbai: The movement of India’s bond market on Wednesday indicates that bond traders and bankers are still not convinced that Reserve Bank of India governor Y.V. Reddy will follow the US Federal Reserve’s example and cut the policy rate.
The yield on the 10-year benchmark government bond in India dipped to 7.28% in early morning trade on Wednesday, its lowest since January 2006, after a 75 basis points rate cut by the US Federal Reserve that brought down the US policy rate to its August 2005 level. But it rose to close at 7.39%—still lower than Tuesday’s closing level of 7.46% but higher than the level touched in early trades.
A bond market rally normally indicates a softer outlook on interest rates and an impending rate cut by the banking regulator. However, the market does not seem to be entirely convinced that RBI will do this when it reviews its monetary policy next week. In fact, bond dealers and bankers are divided on the possibility of a rate cut even though the banking industry is certain Reddy’s monetary policy stance will be “soft”.
Reddy has been tightening the policy to rein in runaway credit growth and cool down some of the overheated sectors in the world’s second fastest growing economy. In the past two years, since January 2006, India’s central bank has raised the upper end of the policy rate by 150 basis points, from 6.25% to 7.75% in six stages. During the same time, the lower end of the policy rate has been raised by 75 basis points, from 5.25% to 6%.
The upper end of the rate is called the repo rate or the rate at which RBI injects liquidity into the banking system (or the rate at which RBI “lends” to banks). The lower end, the reverse repo rate, is the rate at which the banking regulator sucks out liquidity from the system (or the rate at which RBI “borrows” from banks).
Beside hiking the policy rates, RBI has also raised the quantity of cash balance or CRR (cash reserve ratio) that commercial banks need to keep with it from 5.5% to 7.5% in stages to tighten liquidity. Banks do not earn interest on this reserve kept with RBI and it also limits the amount of money they can lend.
Most bankers say RBI will no longer raise CRR and encourage liquidity in the system. O.P. Bhatt, chairman of State Bank of India, the nation’s largest lender, said the Fed decision to cut rates may not have any bearing on RBI policy as the Indian context is very different, but the CEO of a large private bank, who did not wish to be named, said Reddy will certainly follow an easy money policy. That, though, does not mean he will necessarily opt for a rate cut.
A. Prasanna, vice-president, ICICI Securities Primary Dealership Ltd, a firm that buys and sells government bonds, said there is a 50% chance of a 25 basis points cut in the policy rate. “Earlier, the chance was close to zero but now market is expecting that there might be a 25 basis point cut in the repo rate,” he said.
A 23 January report of HSBC Global Research, titled Asia Impact of Fed Rate Cut, said “the case for a reduction (in rate) may well have been sealed by the Fed’s action. As a result, we now expect a 25 basis points repo rate cut, probably at the 29 January meeting. In effect, what we expect to see is RBI shift from its emphasis on controlling inflation to keeping growth going.”
However, bond dealers are not punting on a rate cut as yet and are, in fact, saying there is not much room left for the bond yield to fall further.
“I am bearish on bonds. If one looks at the US Fed and trade in Indian bonds that would be suicidal,” said R.A. Sankaranarayan, a senior dealer with the public sector Bank of India. “In the US, the problem is subprime crisis and recession, in India the problem is of liquidity,” he added.
“The bond yield movement was a psychological issue today. It should pause now,” said Development Credit Bank Ltd’s head of treasury operations Harihar Krishnamurthy. “The attention will be whether the liquidity will be adequate if the FIIs (foreign institutional investors) are exiting the country. Probably a CRR cut will be one that RBI will be pondering,” Krishnamurthy added. Sankaranarayan said he does not expect any rate cut in the upcoming policy announcement.
“We expect another 10-15 basis point decline in bond yields over the next few weeks, with the extent of gains depending on the stance laid out in the upcoming policy review,” said Vikas Agarwal, an analyst with JPMorgan Chase Bank.