The yield on the 10-year government bond surged 10 basis points to hit a five-week high on Tuesday as a jump in India’s retail inflation deepened worries of a prolonged pause in rate cuts by the Reserve Bank of India (RBI).
At 9.15am, the 10-year bond yield was at 6.696%--a level last seen on 19 December--up 10 basis points from its previous close of 6.598%. Bond yield and prices moves in opposite direction.
India’s retail inflation shot to a five-and-a-half-year high of 7.35% in December, breaching the central bank’s threshold of 6%. The inflation print was higher than the 6.20% median estimate of a Reuters survey of economists and the fastest increase since July 2014. In November, retail inflation stood at 5.35%.
Data released by the government’s statistics department on Monday showed that food inflation accelerated 14.12% in December from 10.01% a month ago as vegetable prices surged by 60.5%. Core inflation eased to 3.4% in December.
Many analysts believe that inflation would continue to rise in January, as base effects are more adverse, before readings taper. This may also force the RBI to rethink its accommodative stance at its next policy review meeting on 6 February.
"This reinforces our view of a prolonged pause in rates whilst maintaining an accommodative bias, making it necessary for directed efforts like the special OMOs to restrain the longer-end of the yield curve and excess liquidity to keep the shorter-tenor anchored, aiding transmission," said Radhika Rao, economist of DBS Bank in a 14 January note.
The strategic retreat of monetary policy activism amid falling growth shifts focus to government’s policy guidance at its 1 February Union Budget. Cut in corporate tax, disappointing disinvestment proceeds and elevated crude prices likely lead to fiscal deficit slippage of at least 0.4% of gross domestic product in fiscal year 2020, analysts expect.
Lack of space for monetary easing is also going to put the onus of recovery on a larger fiscal expansion in the upcoming government budget for fiscal 2021. Brokerage firm Nomura Research expects an elevated, albeit marginally smaller fiscal deficit of 3.6% of GDP in FY21 against the current target of 3%.
"Considering the higher than targeted level of inflation and the fiscal challenges with regard to the Government surpassing its fiscal deficit target, the RBI is likely to maintain its status quo on the policy rates in the forthcoming policy meeting. Going ahead, RBI’s monetary policy would remain contingent on the inflation trajectory and the government’s fiscal stance," Care Ratings said in a note.
Meanwhile, the Indian rupee strengthened for the sixth consecutive session today to hit a fresh one-month high tracking gains in Asian peers after the US Treasury Department on Monday said China should no longer be designated a currency manipulator - a label it applied as the yuan slid in August The move cones ahead of Wednesday’s planned signing of the partial Sino-American trade deal.
The rupee traded at 70.77 a dollar, up from its previous close of 70.86.