India markets closed

Bonds rally despite no rate reduction by RBI

Bhavik Nair
Bonds, Reserve Bank of India, policy repo rate, ICICI Bank, global markets, policy rate, CPI inflation

Despite the Reserve Bank of India (RBI) maintaining status quo on policy rate and hiking its consumer price index (CPI) inflation projections, bonds rallied on Thursday after the central bank decided to conduct long-term repo operations at policy repo rate, thereby, leading to a significant drop in short-tenor yields.

In Thursday's monetary policy, the central bank said it will conduct term repos of one-year and three-year tenors of appropriate sizes for up to a total amount of Rs  1 lakh crore at the policy repo rate. "Since June 2019, the Reserve Bank has ensured that comfortable liquidity is available in the system in order to facilitate the transmission of monetary policy actions and flow of credit to the economy. These efforts are being carried forward with a view to assuring banks about the availability of durable liquidity at reasonable cost relative to prevailing market conditions," RBI said.

Short-term yields fell to about two-month lows with the three-year government bond yield closing 19 basis points down at 5.916%, while the five-year yield closed 15 bps down to hit 6.344%. The impact was also seen in long-tenor bonds, with the benchmark yield closing 6 bps down at 6.448% - a six-month low.

Many market participants said the announcement was as good as an indirect rate cut if not better and that was reflecting in the yields which completely ignored other textbook factors like sticky inflation and status quo policy.
As ICICI Bank (global markets, sales, trading & research) head B Prasanna said the policy was a "whatever it takes" moment for India and its policymakers. "The crowning glory of all measures is the provision of long term money through LTRO at the repo rate that is intended towards facilitating better transmission in the bond and loan markets. Besides lowering rates in the short end of the sovereign curve it is also likely to lower corporate bond yields, deposit rates and lending rates," he said.

Indeed, higher CPI inflation had tied the central bank's hands as far as monetary easing was concerned. RBI has hiked its inflation projection to 5.4-5% for the first half of fiscal 2021 from the previous projection of 4.0-3.8%. But that did not stop the central bank from announcing long-term repo operations.

What is noteworthy is the fact that the central bank earlier made its intentions clear of bringing down the term premia for the long-tenor bonds with its Operation Twist and now the long-term repos are expected to keep a downward pressure on short-tenor yields.

PNB Gilts senior executive vice-president Vijay Sharma said, in the policy, RBI is indicating to the market that they have removed the floor for the short-dated yields. "On one hand, the central bank has put a ceiling on the long tenor yields by conducting the Operation Twist in last two months and have not indicated that they are averse to doing more of it in future. On the other hand, the introduction of the long term repos, has removed the floor from the short term yields. This overall had a very positive impact on the market. Furthermore, an explicit statement that there is further space for monetary accommodation is clearly indicating that RBI is not yet done with overall monetary easing," Sharma said.

Serenity Macro Partners founder and managing partner Manish Wadhawan said due to a limited space to cut policy rates on account of the high inflation and the projected CPI, RBI has delivered a stealth rate cut by announcing long-term repos of one-year and three-year at repo rate. "RBI has tried to support growth by incentivising bank credit to specific sectors through dispensing the CRR against those lending for six months," he said.