Banks are big borrowers from RBI term repos, although they have been lenders in the overnight operations. (Naveen Kumar Saini/Mint)
Banks are big borrowers from RBI term repos, although they have been lenders in the overnight operations. (Naveen Kumar Saini/Mint)

Why the bond market is not buying RBI’s friendly monetary policy

  • Liquidity still tops the list of concerns for markets, and the absence of a clear stance on this disappointed bond traders and bankers
  • This explains to a large extent why bond yields inched up and the rupee fell vs the dollar after the RBI policy announcement

Mumbai: Repo rate cut? Check. Inflation forecast lowered? Check. Growth forecast lowered? Check. As monetary policies go, Thursday’s statement had all the elements that showed the Reserve Bank of India (RBI) wants to grab this interlude on inflation and won’t hesitate to cut rates further to spur growth. After all, by their own forecast, headline inflation is likely to remain below the 4% target for two consecutive years now.

The central bank knows this is the right time to give a hand to manufacturers, by bringing down their cost of borrowing, thus giving a boost to economic growth. For this, RBI has brought its repo rate down by 25 basis points and governor Shaktikanta Das said that banks need to do more to pass on these rate cuts.

But not everyone is buying the story that interest rates are headed south.

The key reason for this could be that although the central bank has brought the price of money down, it has done little to make its availability easy.

Liquidity still tops the list of concerns for markets, and the absence of a clear stance on this disappointed bond traders and bankers. This explains to a large extent why bond yields inched up after the RBI policy announcement.

“It was surprising that the MPC (monetary policy committee) chose not to be more proactive on liquidity management, while still deliberating on the need for keeping liquidity neutral in order to aid transmission," said B. Prasanna, head of global markets at ICICI Bank Ltd.

R. Sivakumar, head of fixed income at Axis Asset Management Co. Ltd, echoes similar sentiments. “The market was probably hoping for a stronger statement in support of growth or liquidity, with perhaps a commitment to OMOs (open market operations), or another liquidity tool," he said.

What good is lowering the price of money if its availability remains doubtful. When the risk-free sovereign bond yield has climbed, riskier corporate bond yields will follow. Considering that deposit growth has remained far lower than credit growth, banks are unlikely to cut loan rates and forgo margins, especially when they cannot afford to antagonize depositors by cutting rates for them.

Another reason to doubt rates are heading south is RBI’s own assumptions. Governor Das said the central bank has considered budgeted fiscal deficit numbers in its inflation and growth forecasts. State finances are in a precarious position and the central government has missed fiscal deficit targets more times than it has met them in the past. Market participants are wary of fiscal slippages given the elections this year.

If RBI wants markets to believe that it was willing to lend a hand to growth, it would have to go beyond rate cuts and unclog the liquidity flow. It will also have to take the government’s accounts with a pinch of salt.

Mint's Clifford Alvares in Mumbai contributed to this story.

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