Why did bond yields shoot up post RBI policy? Soumyajit Niyogi of India Ratings explains

India Ratings & Research Director Soumyajit Niyogi.

The Monetary Policy Committee (MPC) voted to keep the benchmark repurchase rate at 4 percent and retained its “accommodative” stance. The Reserve Bank of India (RBI) raised its annual inflation forecast to 5.7 percent from 4.5 percent, which analysts say indicates a rate hike in the coming months. It also lowered the growth projection for FY23 to 7.2 percent from 7.8 percent.

The RBI also decided to introduce a liquidity absorption tool, called the Standing Deposit Facility (SDF), at 3.75 percent, which will now be the floor of the interest rate corridor. By practically making the current reverse repo rate of 3.35 percent, redundant, the central bank has affected an indirect tightening of 40 basis points (bps).

In an interview with Moneycontrol, Soumyajit Niyogi, Director, India Ratings & Research (Fitch Group), shares his view on the policy pronouncement. Edited excerpts:

Q. Why did bond yields rise today?

Monetary policy works through a signalling mechanism to influence system expectation. Today’s policy has given a clear signal that the days of ultra-loose policy are over, and next (on the list) is a repo rate hike. The market had high hopes that the RBI will keep the yield at a lower trajectory. This was not rational. Now the policy communique has clearly brought back focus on inflation dynamics.

Q. Does the announcement of the LAF, SDF corridor indicate a hawkish policy?

The pandemic conditions necessitated the introduction of an ultra-loose monetary policy condition, which was exceptional compared to the conventional approach of easy-neutral and tight policy stances. While the fear of the pandemic has substantially ebbed, the growth-inflation dynamic turned out to be more wobbly. So, the shift from ultra-loose to accommodative policy was obvious. RBI has resorted to a policy corridor of 25bps from 65bps at one go, and this was delivered tactically through a shift from Reverse Repo to SDF. The tactical movement helped to ensure lower volatility in the market.

Q. Will the gap between short-tenor and long-tenor narrow?

With the restoration of normalcy in the liquidity contour, the short-term rate should further move up. Moreover, rising input costs and preference to hold higher liquidity in the balance sheet amid a challenging environment would propel higher issuances in the CP market. Hence, the higher supply in the market and normalisation of liquidity to push the short-term rate higher. However, unless the repo rate moves up, the gap is unlikely to come down sharply.

Q. Was the policy on expected lines?

In the backdrop of elevated geopolitical tensions and boiling commodity prices, the monetary policy was (anyway) bound to be altered.

Q. Will green finance pick up in India?

The importance of environmental, social and governance (ESG) has gained meaningful traction in the last two years. Both globally and domestically, lenders and investors have geared up to examine credit through the lens of ESG by adopting a stringent framework, explicitly or implicitly. This development is expected to gather more traction in the near future. Therefore, entities and sectors that are more relevant under the ESG contour will face additional layers of scrutiny, and in some cases may face challenges in securing long-term financing. It is also possible that the lender or investor may add extra premium to cover up some of the ESG-related risks.

Q. Do you think large borrowing programmes from April 1 will weigh on bond yields?

Large borrowing amid adverse inflationary conditions will always keep yields on the higher side, and high supply will remain a concern not only for FY23, but also in the foreseeable future. It is always challenging to absorb such a large supply, and now the macro condition has turned adverse.

Q. Why have we not seen any issues in the corporate bond market since the last two weeks?

I think both investors and issuers were waiting for a signal from the monetary policy for pricing.

Q. Could we see more corporate bond deals being scrapped?

Contrary to Government borrowing, issuance in the corporate bond market is expected to be benign, though CP and CD markets may show good activity. Unless we see oil moving above $125/bbl or a further escalation of the war, chances of an issue being scrapped will be very low.