India's bonds slump; RBI raises CPI forecasts, cuts SLR

By Suvashree Choudhury

MUMBAI (Reuters) - India's benchmark 10-year bond slumped to its lowest level in nearly five months after the Reserve Bank of India (RBI) raised inflation projections, sharply reducing the prospect of rate cuts, while lowering the mandatory amount of bonds banks must keep with it.

The decisions were taken as part of the RBI's policy meeting on Wednesday, with the central bank keeping the repo rate on hold at 6 percent as widely expected, after cutting it by 25 basis points at its last policy meeting in August.

But the rupee rallied to as much as 64.9450 per dollar from its close of 65.49 as the RBI appeared to lower the chances of rate cuts by raising its inflation forecast to 4.2-4.6 percent in October-March, compared with its previous projection of 4.0-4.5 percent, still historially low for India.

The RBI also cut the statutory liquidity ratio by 50 basis points to 19.50 percent from mid-October, in a bid to spur banks into lending more, and the amount of bonds that banks can hold till maturity to 19.50 percent by end-March 2018 from 20.25 percent now.

The moves, along with an economic growth projection that was higher than analyst estimates, appeared to shut the door to using rate cuts to revive an economy growing at its slowest pace in over three years.

"It does look like RBI is going to be on extended hold," said R. Sivakumar, head of fixed income at Axis Mutual Fund.

"There is very little evidence to suggest anything which should have marked up their inflation forecast. To that extent, it's a little surprising."

The benchmark 10-year bond yield rose as much as 6 basis points to 6.71 percent, the highest since May 19. Meanwhile, the five-year benchmark overnight indexed swap was at 6.31 percent compared with 6.26 percent on Tuesday.

One analyst estimated the SLR cut could free up about 553 billion rupees ($8.51 billion) for banks.

Further reducing the prospect of rate cuts was the RBI's gross value added growth projection of 6.7 percent for the year ending in March, down from 7.3 percent previously, a measure of growth it prefers.

The forecast is higher than markets' estimates of around 6 percent, indicating the central bank's increased confidence in the economy.

($1 = 65.0100 Indian rupees)

(Additional reporting by Abhirup Roy; Editing by Nick Macfie)