RBI Governor says won’t be excessively harsh on inflation but bonds still face selloff. Here’s why

Reserve Bank of India Governor Shaktikanta Das said that while the central bank will continue raising interest rates to curb high inflation, the objective was to ensure that the market doesn’t get any shocks and that growth revival is not derailed.

The bond market, however, doesn’t seem to be listening.

Yield on the 10-year benchmark 6.54 per cent 2032 paper climbed as much as 4 basis points on Friday, with the bond last trading at 7.33 per cent. Bond prices fall when yields rise.



“We are committed to containing inflation,” Governor Das told the Economic Times in an interview. “At the same time, we have to keep in mind the requirements of growth. It can’t be a situation where the operation is successful, and the patient is dead.”

The RBI took markets by surprise earlier this month by announcing a 40-basis-point repo rate hike after an unscheduled meeting of the central bank’s Monetary Policy Committee.

Das also announced a 50-basis-point increase in the Cash Reserve Ratio that banks have to maintain; a move clearly aimed at reducing a massive liquidity surplus in the banking system.

With India’s Consumer Price Index-based inflation soaring well past the RBI’s mandated target band of 2-6 per cent and factors such as surging global commodity prices presenting strong upside risks to consumer prices, it is taken as a given that more rate hikes are on the cards.

Yield on the 10-year benchmark government bond shot up to an around-three-year high of 7.46 per cent in the days following the RBI’s unexpected rate hike on May 4.

INFLATION, DEMAND-SUPPLY DYNAMICS A WORRY

While bond yields have cooled off since then, traders believe that the outlook for the market is an unfavourable one, given that there is much more room for interest rates to head up.

Expectations of how aggressive the RBI’s rate hikes may be have been tempered after the government recently announced a slew of measures including a cut in fuel excise in order to manage inflation from the supply side.

However, with global crude oil prices sustaining well above the $110 per barrel mark, the odds are tilted in favour of more rate hikes than less, bond traders believe.

Global crude oil prices have surged around 50 per cent in 2022 owing to supply disruptions caused by Russia’s invasion of Ukraine. Given that India imports more than 80 per cent of its oil needs, this poses a major upside risk to inflation.

After surging to a two-month high on Thursday, Brent crude futures eased marginally on Friday, trading 11 cents lower at $117.29 a barrel on Friday. WTI crude futures for July delivery fell 19 cents to $113.90 a barrel.

What makes matters more complicated for the market is the huge load of bond supply scheduled for the current year.

The government announced a fresh record-high gross borrowing programme of Rs 14.95 lakh crore for the current year in the Budget.

Accounting for bond switches carried out in early 2022, the gross bond supply stands at a massive Rs 14.3 lakh crore.

Moreover, unlike the past couple of years, in the current year, the market does not have the comfort of knowing that the RBI will step in as a major buyer of government bonds.

Given its aim of bringing down the liquidity surplus in the banking system – currently estimated at around Rs 3.5 lakh crore – the central bank cannot go on a bond shopping spree to improve demand-supply dynamics in the bond market.

Bond purchases by the RBI add durable liquidity in the banking system.

In fact, a niggling fear in the minds of bond traders is that the government may announce even more borrowing later in the year as the Centre is taking a large fiscal hit after reducing excise duties on petrol and diesel.

Government officials downplayed such fears earlier this week, but the Centre has more than once increased its borrowing in the latter part of the calendar year once it receives more clarity on its finances.

“There is really nothing new in what the Governor has said; the fact remains that interest rates are going to go up,”

Primary Dealership’s Head of Trading Naveen Singh said.

“The off-policy rate hike shows that there was a requirement for urgency. Today, the market has sold off because there was a bit of a rally yesterday, oil prices are up and there is a Rs 33,000 crore auction,” he said.

Elevated sovereign bond yields lead to higher borrowing costs across the economy as gilt yields are the benchmarks on which a vast variety of credit products are based.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)

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