Bond market expects RBI to change policy stance in February review

Continuous VRR indicates accommodative approach on liquidity

Bond market participants are expecting the Reserve Bank of India (RBI) to change its stance in the February policy review to neutral from withdrawal of accommodation, citing the continuous variable rate repo (VRR) auctions.

This optimism stems from the perception that the central bank is adopting an accommodative approach towards liquidity.

“RBI is trying to adjust liquidity and bring it close to neutral or zero. The way RBI spoke in the last policy, it doesn't look like it wants a hike anytime soon,” said Naveen Singh, vice-president of ICICI Securities primary dealership.

“If they don't want to cut now, but they also don't want to hike, then what's the point of keeping withdrawal of accommodation stance? They can very well come to a neutral stance. And, a neutral stance doesn't stop RBI from hiking if it wants to.

It should not unexpectedly change to an accommodative stance, but at least to neutral,” Singh said.

Jayanth Varma, an external member of the monetary policy committee, was the only one to recommend a neutral stance during the December policy review.

Consequently, the market has been strategically taking long positions in government bonds, said dealers. “A majority of the people, if not everyone, is taking long positions (buying) because the market is factoring in that the RBI would change its stance in February,” said a dealer at a state-owned bank.

Yield on the benchmark 10-year government bond has fallen by 3 basis points (bps) in January so far. In December, the yield had fallen by 11 bps.

However, a segment within the market feels that the central bank could persist with its stance of withdrawing accommodation. It may delay any change until at least April.

 “A minority section of the market thinks that a change in stance in February is possible. The general view is that April is when the change in stance happens,” said Vijay Sharma, senior executive vice-president at PNB Gilts.

“Even after this Rs 1.75 trillion VRR, the liquidity is still in deficit mode. It is apparent that through the recent consecutive VRR auctions, RBI is ensuring that tightness in liquidity is not stretched. However, it is too early to say that RBI is taking an accommodative stance. So, it is still a wait-and-watch situation.” he added.

The central bank has been conducting VRR auctions in order to infuse liquidity into the banking system. In the 13-day VRR auction conducted by the RBI on Friday, bids were received for Rs 3.92 trillion, against a notified amount of Rs 1.75 trillion.

In the preceding VRR auctions, the central bank received a strong demand, with banks submitting bids ranging between 2.5 and 3.2 times of the bidding amounts. This is due to tight liquidity conditions in the system. Liquidity remained largely in deficit mode in the third quarter. The central bank had conducted a VRR auction after six months on December 15.

The deficit liquidity in the banking system widened to Rs 2.1 trillion on Monday, according to data from the central bank. 

Market participants observed that despite the higher-than-expected US consumer price index (CPI), the US Treasury yield softened. This reinforced the anticipation of a rate cut by the Federal Reserve in March.

On the domestic front, the CPI data came in lower than expected, heightening expectations that the RBI may change its approach towards liquidity tightening.