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Business News/ Opinion / Online-views/  Bond yields drop on hopes of further rate cut by central bank
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Bond yields drop on hopes of further rate cut by central bank

Bond yields drop on hopes of further rate cut by central bank

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Mumbai: Bond prices rose, pushing down benchmark 10-year yields to a level last seen in January 2006, as dealers pinned their hopes on another rate cut by the Reserve Bank of India, or RBI, to bolster slowing economic growth.

The yield on 10-year bonds, which was 7.50% early this week and 8% in October, dropped to 7.0984% in heavy trading, but closed at 7.20% as bond dealers cashed in on the rise in prices. Bond prices and yields move in opposite directions.

On 19 January 2006, the yield had dropped to 7.096%, according to Bloomberg data. At that time, the RBI policy rate was at 6.50%. The rate now stands at 7.50% after RBI slashed it by 150 basis points in two moves over the past four weeks. One basis point is one-hundredth of a percentage point. Before the first rate cut on 20 October, the yield was 7.704%.

Also See On Decline (Graphic)

RBI has cut rates to ease a liquidity crunch ensuing from the global financial market turmoil and to bolster economic growth that is slowing from an average pace of 8.9% in the past four years. Growth is expected by RBI to slacken to 7.5-8% in the current fiscal year.

With two bond auctions worth Rs9,000 crore, the government’s Rs1.45 trillion annual borrowing programme for fiscal 2009 was completed on Friday. But bond dealers and economists expect the government to overshoot its borrowing target for the year to bridge its widening fiscal deficit. Still, oversupply of government paper may not push up yields.

“As I can see today, the government is going to overshoot the borrowing target by Rs25,000-35,000 crore to fund its infrastructure needs," said Pradeep Madhav, managing director, STCI Primary Dealer Ltd, a firm that trades in government bonds. “We could witness this coming by December and January."

“However, it won’t affect the bond market as oil prices are coming down, inflation is getting tamed and the interest rate cycle has clearly changed," he added.

A declining inflation rate, aided by falling crude oil prices, has given room for RBI to cut rates. The wholesale price-based inflation for the week ended 8 November was at 8.9%, a five-month low. RBI’s year-end target of inflation is 7%.

The global economic slowdown has propped up bond prices as central banks all over the world slash interest rates to boost liquidity and bolster growth. With every cut, bond yields also decline.

Bond yields shot up to as much 9.5% in mid-July 2008 when the inflation rate was inching towards 13% and oil prices were at $140 a barrel. RBI raised its policy rate by 125 basis points to 9% and the cash reserve ratio (CRR), the portion of deposits that commercial banks are required to keep with the central bank, by 150 basis points to 9% since the beginning of the fiscal year to combat inflation.

But the collapse of Wall Street investment bank Lehman Brothers Holding Inc. in mid-September dramatically changed the scenario as it led to an unprecedented liquidity crunch across the globe.

This forced the Indian central bank to cut its policy rate by 150 basis points to 7.5% and banks’ CRR by 350 basis points to 5.5% in phases.

“The government will take care of the liquidity by any means...to ensure economic growth does not suffer," said Madhav.

According to Kunal Shah, managing director of Derivium Capital and Securities Pvt. Ltd, a firm that trades in government and corporate bonds, the government might take a call on additional borrowings after examining its advance tax collections. Indian firms pay corporate tax every quarter in advance in accordance with their projected profitability.

“There could be some small borrowings which won’t affect the market much. As of now, the market has factored in at least 50 basis points cut in repo and reverse repo rates," said Shah. The repo rate, at which RBI infuses liquidity in the system, is now 7.5%, and the reverse repo rate, at which the central bank sucks out excess liquidity, is 6%.

“Everyone is expecting a rate cut," said Anoop Verma, associate vice-president at Development Credit Bank Ltd.

“There is a slowdown in the economy; so interest rates will fall. This is evident from the bond yield which is falling by 10 basis points almost every day. I think 50 basis points cut is already factored in; if there is a cut bigger than that we will will see yields falling further," said Verma.

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Published: 21 Nov 2008, 10:08 PM IST
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