Mumbai:Indian stocks fell and bond yields rose to a near 18-month high on Monday as investors bet the central bank was poised for more interest rate hikes after a surprise increase late last week.
The Reserve Bank of India, citing intensifying inflationary pressures and a steady economic recovery, caught investors offguard with a 25 basis point (bps) tightening late on Friday, after local markets had closed.
Analysts and investors had expected a rise of 50 bps points but not until the central bank’s policy review on April. Many now see a 25 bps rise at that meeting next month.
A RBI deputy governor had earlier ruled out any inter-meeting rate action except under unforeseen circumstances.
“The market was getting complacent that the RBI was unlikely to act in between policy reviews,” said B. Prasanna, CEO of ICICI Securities Primary Dealership.
“Since that has happened, I think some kind of a re-rating will happen because of that, s.o yields will be headed higher as we go into the borrowing programme and the next policy and it will be a slow grind upwards (on rates),” Prasanna added.
The main stock index fell as much as 1.4% led by financials, before paring some losses. India’s move also weighed on global markets, stoking investor concerns about riskier assets.
India’s benchmark 10-year bond yield jumped to a near 18-month high of 8.03 percent in opening trades but eased later in the day. At 3:08pm it was at 7.88 percent, compared with its Friday’s close of 7.83%.
With the Reserve Bank of India and government officials consistently underestimating inflation, many observers said a rate rise was long overdue and expect Friday’s tightening to be a prelude to further such moves, especially given the time it takes for changes in policy rates to trickle through to real rates in India.
“All in all, this was a sensible, albeit belated rate move and one which we expect to be followed by several further steps starting at the 20 April meeting,” Robert Prior-Wandesforde, senior Asian economist at HSBC, wrote in a note.
India’s central bank deputy governor and a top government adviser both said on Monday that they expect inflation to ease in coming months, but markets appeared sceptical.
“The RBI’s rate hike shows that it expects inflation to get worse before it gets better, though the baby steps show that it is probably not as sanguine about growth as it would like to seem,” said Sujan Hajra, chief economist at Anand Rathi Securities in Mumbai.
“In India double-digit inflation always has a political connotation and this move was designed to show that the RBI is acting upon inflation,” he added. The government has faced opposition-backed protests over rising prices.
India’s headline inflation topped expectations and came within touching distance of double digits in February, compared with the RBI’s projection of 8.5 percent at the end of March.
While inflation in India had long been driven by high food prices beyond the scope of monetary policy, it has been creeping into the broader economy, with demand-side pressures mounting.
The move on Friday makes India just the second Group of 20 economy, after Australia, to begin lifting rates since the global financial crisis ebbed. Other central banks in Asia are seeing rising inflation albeit with limited pull from the demand side.
“The central banks in that sort of situation are having to wear a hawkish mask because there is a need to dispel expectations of accelerating inflation,” said UBS economist Philip Wyatt in Hong Kong.
“At the same time there’s clearly not a strong justification to hike rates aggressively and to squeeze the brakes and drain liquidity significantly,” he said.
The benchmark five-year overnight indexed swap rates were marginally higher at 6.82/86 percent, from 6.79/82 percent at the previous close, but the one-year rate jumped to 4.95/98 percent from Friday’s 4.82/85 percent.
“The market is drawing comfort from the caliberated manner of the exit, so if its 25 bps in April and then 25 bps every policy or intra-policy, and the yield curve is as steep as ours, then impact should be minimal, except at the very short-end,” said Hitendra Dave, head of global markets at HSBC India.
Markets also are looking ahead to a March 29 meeting between central bank and finance ministry officials, where they will decide on the borrowing calendar for the first half of fiscal year 2010/11.
India is budgeted to borrow a record gross Rs4.57 trillion ($100 billion) in the fiscal year starting April 1, with most of that expected in the first half of the year.
The partially convertible rupeewas at Rs45.490/495 per dollar, marginally above its previous close.