RBI fires up bond market

50-bp rate cut takes bond yields near 26-month low

The bond market could not have expected for more, with a surprise rate cut as sharp as 50 basis points (bps) compared with an expectation of 25 bps, which took the yield on the 10-year bond down near a level last seen 26 months ago.

In the year’s fourth bi-monthly monetary policy review, the Reserve Bank of India (RBI) reduced the repo rate (at which banks borrow from the central bank) by 50 bps to 6.75 per cent due to which, the yield on the 10-year benchmark bond ended at 7.61 per cent on Tuesday, compared with the previous close of 7.73 per cent. The yield on the 10-year bond had ended at 7.56 per cent on July 15, 2013.

“Bond market participants were pleasantly surprised with a 50 bps reduction in the repo rate. This cut has been delivered against the backdrop of a prospective US Fed interest rate hike, recent weakness in emerging market equities and bonds, weakening of emerging market foreign exchange and stable food prices,” said Dhawal Dalal, executive vice-president and head (fixed income) at DSP BlackRock Investment Managers.

The other factor contributing to the fall in bond yields was the enhancement of the investment limit for foreign portfolio investors. RBI said on Tuesday the limits for FPI investment in the central government securities will be increased in phases, to five per cent of the outstanding stock by March 2018. “In aggregate terms, this is expected to open up room for additional investment of Rs 1.2 lakh crore in the limit for central government securities by March 2018 over and above the existing limit of Rs 1.54 lakh crore for all government securities,” said the central bank.

The enhancement in limits will result in additional demand for government bonds and it shall ensure the government’s borrowing programme sails smoothly. However, experts believe the fall in yields might not be sustained. “We see any rally in long-term local currency fixed income instruments as short-lived and global risk aversion returning as the primary driver behind market movements. The yield on the 10-year sovereign paper should, thus, head back higher to 7.65-7.70 per cent over the next fortnight,” said Abheek Barua, chief economist, HDFC Bank.