RBI's dovish policy helps bonds cut back on Union Budget losses

Bond yields, which shot up significantly after the Union Budget announced a larger-than-expected borrowing, got some relief after the central bank delivered an extremely dovish policy

Bond yields, which shot up significantly after the Union Budget announced a larger-than-expected borrowing for the next financial year, got some relief on Thursday after the central bank delivered an extremely dovish policy without tampering with the reverse repo rate, which was widely expected.

Yields on the 10-year government bond fell 7 bps to close the day at 6.73 per cent. Bond yields have softened in the last two trading sessions after the RBI cancelled the weekly auction that was scheduled for Friday due to the comfortable cash position of the government.

“We found the MPC statements and the comments from the RBI governor to be needlessly dovish. The bond markets have already priced in a move away from accommodative policy in the months to come. Maybe they felt some segments of the bond market are over-reacting and hence wanted to temper the actions by maintaining the status quo,” said Arvind Chari, CIO, Quantum Advisors.

The Union Budget, which was presented on February 1, announced a net borrowing of Rs 11.2 trillion and a gross borrowing of Rs 14.95 trillion — much above what the street was expecting. From 6.68 per cent pre-Budget, yields on the 10-year benchmark government bond jumped to 6.89 per cent after the Budget.

This was the 10th consecutive policy meeting when the monetary policy committee has maintained a status quo. The last rate revision was in May 2020. “We maintain our negative outlook on Indian government bonds on unfavourable demand-supply dynamics. While we believe measures such as cancellation of auctions provide immediate relief to markets, medium-term supply concerns will persist,” said Anubhuti Sahay, head, South Asia Economic Research, Standard Chartered Bank.

The extreme dovish stance impacted the foreign exchange market, too, as the rupee weakened against the dollar. The domestic unit ended 15 paisa higher than its previous close on Tuesday.

“We think the RBI’s dovish rhetoric relative to market expectations will act as another headwind for the INR (beside the already wide trade deficit), particularly at a time when major central banks are adopting a much more hawkish stance. We maintain our targets for USD-INR at 75.50 by end-March and 77.5 by year-end,” Sahay said.

RBI governor defended the dovish stance even if global central banks are tightening as he said the characteristic of Indian inflation is different from other countries.

Market participants also said with India’s inclusion in the global bond index by the end of the year is still not clear (the Budget was silent on the issue), this would mean the inflows that were expected during the later part of the year, may not materialise now.

“Our approach has been calibrated. Last year, we introduced the FAR — the fully accessible route — where there were no limits on FII or investment from outside can come in. Bond inclusion works both ways… you have greater flow of resources in the country and when you have when index become adverse there could be certain outflows. The strongest point of our debt profile is that it is largely, over 90%, denominated in Indian rupee. Its exposure to foreign exchange in our domestic government borrowing, is just 5-6 per cent,” Shaktikanta Das, governor, RBI, said.