RBI's communication flip-flop baffles market

Abrupt change seen from April such surprises create volatility, complain watchers

Reserve Bank of India (RBI) governor D Subbarao is not known to have a penchant for surprising the market, unlike his illustrious predecessor, Y Venugopal Reddy, who mastered the art of catching the market offguard.

Rather, Subbarao — who took charge at the height of the global financial crisis in 2008 — made a departure from this on the grounds that a surprise during uncertain times would add to volatility. In fact, he introduced the mid-quarter reviews, which reduce the gap in RBI’s policy communication by half, so that the markets get the right signal at frequent intervals.

The stock market rallied 1.4 per cent last week on the hope of a rate cut, while yields on the 10-year benchmark bond softened 30 basis points during the same period. The economic crisis is not over by any means; it has become more complex and uncertainties continue. But Subbarao seems to have had a change of heart, if on Monday’s mid-quarter policy statement is any indication.

TOPSY TURVY

• After today's policy announcement, equity markets tanked, yields shot up, so did short-term rates
• Rates on three-month commercial paper and certificate of deposit went up 25 basis points
• Market surprised by policy tone. The hawkish note is a U-turn from the one announced in April 

After on Monday’s announcement, which kept the policy rate and the cash reserve ratio unchanged, equity markets tanked, yields shot up and so did short-term rates. Rates on three-month commercial paper and certificates of deposit, showing a downward trend in the past couple of months, reversed the trend and went up 25 bps.

“The surprise move to leave all rates unchanged resulted in 10-year government security trading higher by 11 bps to 8.14 per cent and the rupee trading close to 40p lower at Rs 55.8 per dollar,” said Citigroup in a research note.

Apart from the absence of action on rates, the market was also surprised by the tone of the policy.

“What is disturbing is the inconsistency in the language of this policy and the last one. The tone is much more hawkish this time. While some statements from RBI officials seemed to condition the market for a rate cut, the policy announcement not only kept the rate unchanged but maintains a hawkish tone,” said Abheek Barua, chief economist, HDFC Bank. “This kind of surprise unnecessarily creates volatility.”

The head of treasury of a public sector bank said: “Earlier, we were expecting a 50-bps cut, though later a 25-bps cut was expected. The bond yields and short-term rates moved taking a rate cut into consideration. However, with no rate cut on Monday, money will become expensive.”