Only a fourth of all economists surveyed by Bloomberg had anticipated a rate cut in the Reserve Bank of India’s (RBI’s) February monetary policy, even though nearly everyone was pricing in a shift in the central bank’s stance from “calibrated tightening" to “neutral".

But a look at the bond markets shows that while the rate cut may have been a positive surprise, traders are weighed down by other concerns. “Normally, a shift in stance and a rate cut would have caused a 10-12 basis points drop in bond yields. The markets’ response was far more subdued primarily because of worries about large supply of government paper, and a concern that RBI may reduce the quantum of open market operations," says R. Sivakumar, head (fixed income) at Axis Mutual Fund. Bond yields on the benchmark 10-year paper fell only three basis points on Thursday.

A week ago, the government’s interim budget suggested gross market borrowing of more than 7 trillion, far higher than the Street’s estimates. The markets are also worried about the credibility of the fiscal deficit numbers, especially with regards to revenue assumptions. It’s hardly surprising bond yields have been firm.

According to the head of research at a multinational brokerage firm, “The difference between the policy rate and current bond yields is already higher than historical averages, and another rate cut will force the markets to change their stance."

Apart from concerns about the government’s finances and its high borrowing, markets are also concerned about political uncertainties in the run-up to the general election. In fact, because of all of these concerns, the rupee too has remained under pressure, even while most other emerging market currencies rallied after the dovish statements by the US Federal Reserve early last month.

While the rate cut took centre stage in the policy announcement, the central bank also simultaneously announced some interesting market development and regulation policies.

“The central bank’s market development measures included the important change that now allows foreign portfolio investors (FPIs) to hold paper of a single corporate. Of course, more market development measures are needed to attract foreign portfolio flows, although incrementally this move is a clear positive," says Sivakumar of Axis Mutual Fund.

Earlier, there was a single-issuer limit of 20% for corporate bonds, which worked against some global funds that were interested in buying debt of only select names.

While this relaxation is a welcome move, some other proposals to attract foreign flows lack substance. RBI said it will form a task force on offshore rupee markets and issue new guidelines to boost the interest rate derivatives market.

“This is a movie we’ve seen before," says a market participant cynically. The view was shared by a forex broker, who says that RBI is still to conclude its study on the need to extend trading hours for the exchange-traded currency derivatives market, months after it began the review last year.

While the export of India’s financial markets has been written about in the past, the problem of high rupee trading in offshore markets has gone from bad to worse. Recently, even an exchange in Russia launched a rupee-dollar futures contract. Ideally, having the advantage of a wide range of participants should have ensured that the bulk of rupee trading happens onshore. But a large number of restrictions and policy flip-flops have made offshore markets far more attractive.

Of course, it must be noted here that some positive steps have been taken, such as allowing FPIs in exchange-traded currency markets and increasing position limits. But, on the whole, development has lagged behind what the markets really need, and it’s heartening that RBI is acknowledging this.

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