RBI policy to hit bonds, 10-yr yields may see 8.40%: Nomura

The bond yields can rise up to 8.40 percent.from current levels on RBI governor Raghuiram Rajan’s fairly hawkish policy stance, says Neeraj Gambhir of Nomura.

In his debut policy, Rajan raised repo rate by 25 bps to 7.5 percent, but reduced the marginal standing facility (MSF) rate by 75 basis points from 10.25 per cent to 9.5 percent. (Read More)

He further added that bonds will give up all the gains they saw in the last few days, which will hit bank treasuries. "There are mark to market losses on bond portfolios and that is going to impact the pricing capability. With this, any hope of swift reduction in interest rates to support growth is completely faded out," he elaborated.

Below is the edited transcript of Neeraj Gambhir’s interview with CNBC-TV18

Q: Would you say that this is a hawkish stance from the Reserve Bank of India (RBI)?

A: I would say fairly hawkish because nobody was anticipating a repo rate increase and a 25 bps repo rate increase is a surprise for the market. The market was expecting 50-100 bps marginal standing facility (MSF) reduction and 75 bps is in the middle of that range.

The normalization of CRR requirement is positive for banks, but at the end of the day, the policy seems to be focused on inflation. The initial sense that Dr. Rajan gave in his first speech that he is going to be fairly focused on inflation and inflation is going to be his key variable to guide his policy making. That is coming out through this policy. So, I do feel that bond market is going to react negatively to this policy and the curve will start steepening from here onwards.

Q: How will a bank treasury be affected? Will there be mark to market (MTM) losses on corporate bonds on CPs that we are holding by September 30 given this signaling on repo but coming down of the overnight rates as well will there be some narrowing of margins. How will a bank treasury be affected?

A: One is very important statement according to me that they have made is that the spread between the MSF rate and the liquidity adjustment facility (LAF) rate is been brought down to 200 bps. If that is the objective to maintain the spread in 200 bps range then the question in my mind comes is that will there be a further reduction in MSF rate especially given the fact that LAF -- there is a trend or there is a potential for the trend for the LAF rates to go up.

The second point is, an important measure that the market was anticipating them to do was to increase the amount of liquidity that is available under LAF. That hasn’t been done. So, to my mind the further withdrawal of these important liquidity measures will be in the form of increase of the quantum of money available under LAF that is provided if the rupee continues to behave in a more stable and appreciating bias basis.

The bond market has given up a lot of gains yesterday. The 10-year bond yield is inching towards 8.30-8.35 level. I do feel that given the stance of the policy and given the fact that further action is being linked to what happens to the currency in the near term, the market is going to be quite jittery. I do feel that the bond yields can inch upwards towards 8.40 or level and that basically would mean that all the gains that we have seen so far especially in the last couple of day are going to be given back. This is not a very good sign for the bank treasuries. There are mark to market losses on bond portfolios and that is going to impact the pricing capability.

I do feel that with this any hope of swift reduction in interest rates to support growth is completely faded out. So, banks will have to start pricing in to some extent some level of endurance in the liquidity measures. I feel that there will be pricing in the deposit rates and lending rates. All in all, I do feel that it is a fairly hawkish policy and it will have its impact across the yield curve, across the lending rates of the banks as well as on the borrowing rates for the banks.