Policy rate hikes play havoc on the bond portfolio of investors and the outburst typically reflects in a sharp rise in bond yields. Yet, the Reserve Bank of India’s announcement of a 50-basis-point hike in its repo rate that was accompanied by enough hawkishness on inflation has moved the bond market in the reverse direction.
The 10-year government bond yields slipped roughly 8 basis points to 7.45 percent after RBI Governor Shaktikanta Das concluded his virtual policy speech. Bond yields move opposite to prices which means a rise in yields reduces the value of the bond holdings. One basis point is one-hundredth of a percentage point.
Shorter four-year bond yields dropped 12 basis points, while three-year bond yield lost 9 bps and two-year bond yield erased over 14 basis points.
What is behind this apparent counterintuitive move in the bond market?
Bond investors took comfort from the fact that the RBI was willing to take measures to ensure that the government's market borrowing goes without a hitch. This could mean that the central bank is open to steps that may cool yields and bring down the government's cost of borrowing.
“RBI monitoring government securities market very closely. We will take necessary steps as and when required,” Das said in his virtual speech. He added that he is not listing all the measures that the RBI can take but that the central bank would ensure the orderly completion of the government’s borrowing plan.
The central government will borrow a massive Rs 14.31 lakh crore from the domestic bond market this year, of which Rs 8.5 lakh crore would be borrowed in the first half of FY23.
"While further rate hikes remain clearly on the table, with the reference to the revised repo rate of 4.9 percent remaining below the pre-pandemic level, the comment on the orderly completion of the government borrowing programme has served to cool the 10-year G-sec yield," said ICRA chief economist Aditi Nayar. "However, the up-march in the yields will now be somewhat shallower than our earlier expectations."
Yet another comfort was the absence of a hike in cash reserve ratio (CRR).
A CRR hike would have impounded liquidity, driving up yields sharply. Since bonds are fungible, the reduction in the quantity of liquidity has a greater impact on yields than a rate hike. As such, the 50-bps repo rate hike was all but priced into bonds.
The RBI's Monetary Policy Committee (MPC) voted unanimously to hike the repo rate, the key policy rate at which the central bank lends short-term funds to banks, by another 50 bps to 4.90 percent. But the CRR was left unchanged at 4.50 percent.
That said, bond yields could harden in the coming days, depending on how inflation data comes. The RBI has raised its forecast for inflation in FY23 to 6.7 percent from 5.7 percent in the April policy. In essence, the central bank expects inflation to be elevated this year, beyond its comfort.
"The RBI’s upward revision of the inflation forecast for FY23 to 6.7 percent from 5.7 percent in April, was also in line with our expectations, but still lower than our forecast of 7.2 percent. So, we believe that we are still far from the finishing line and that more frontloaded rate hikes are on the offing,” said Aurodeep Nandi, India Economist and Vice-President at Nomura.
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