Bond yields decline; fuel hopes of further monetary easing

Short term rates to fall further, WPI inflation slipped to sub-5 level to stand at 4.89% in April against 5.96 in previous month

With wholesale price inflation (WPI) falling below five per cent, yields on government bonds across the tenure have seen a sharp fall, fuelling hope for a further 25 basis point cut in the repo rate by the Reserve Bank of India (RBI) in its monetary policy review in June. This has also set the stage for further easing of interest rates on short-term instruments like commercial paper and certificate of deposits.

Bond dealers and treasury executives said there was across the board fall in yield (about 10 basis points). While being an initial response, it was an overreaction, they said. But, the development has given a boost to the expectation that there would be further monetary easing (cut in key policy rate) by RBI in its mid quarter review.

The yield on benchmark 10-year government paper (8.15 per cent 2022) nosedived to 7.47 per cent at close of trading, down by 11 basis points over the previous close, according to Clearing Corporation of India data. The yield on benchmark in opening trades was 7.58 per cent. The WPI-based inflation plunged to sub-five level to stand at 4.89 per cent in April against 5.96 per cent in the previous month. This is the lowest level since 2009.

With the economy in slowdown mode, the expectation is going to build further for RBI to continue to ease rates for pushing growth. Abheek Barua, chief economist, HDFC Bank, said a 25 bps repo rate cut was expected at RBI’s mid-quarter review in June followed by possibly one more repo rate cut of 25 bps over the remainder of 2013.

India Ratings & Research said it expected a sharp decline in headline inflation along with retail inflation in April 2013 to shift RBI’s focus back on growth, thus increasing the probability of further monetary easing in FY14. RBI had reduced the repo rate by 25 basis points to 7.25 per cent in its annual policy for 2013-14.

The first substantial impact may be seen when RBI fixes coupon rate for new 10-year benchmark. The auction for new paper is slated for Friday. The yield “when issued market” for the proposed paper was ruling around 7.32 per cent.

P Pradeep Kumar, deputy managing director and group executive (global markets), State Bank of India, said yields would ease the downward trajectory. “The sharp fall in 10-year yield is an initial reaction and may stabilise around 7.5 per cent,” he said. Concurring with the SBI executive, N S Venkatesh, chief general manager and head of treasury, IDBI Bank, said, “We are now in a downward rate spiral.”

The effect may not be just limited to a drop in market yields. The short-term interest rates (up to one year) may also soften further. A treasury head with a private sector bank said the coupon rate for term paper (three months to one year) were already down by 75-100 basis points over the end of March 2013. If liquidity improves further, short-term rates may see some further easing.