The Reserve Bank of India cut the repo rate by 25 basis points to 7.50 per cent, as expected at the monetary policy review announced last Tuesday. RBI once again highlighted that the room for further easing is "quite limited" given the high current account deficit and sticky inflation. Consumer price inflation, in particular, driven by high food prices remains high at around 11%. Thus, while RBI has now cut the repo rate in two successive policies, the accompanying cautionary comments made the markets nervous taking the benchmark 10-year government bond yield higher by 10 basis points for the week. As a matter of fact, markets closed lower for all remaining four days of the week. Corporate bond yields also inched up higher by 10 bps. Money market rates, though, eased by another 10-15 bps across the curve up to one year, driven by strong demand from mutual funds even though liquidity tightened further with liquidity adjustment facility borrowings surging to close to Rs 1.5 lakh crore.
With the borrowing programme for the new year scheduled to be kicked off in April, fixed income markets are suggesting a steepening of the yield curve in near term with traders preferring to stay in the shorter end.
Even though trade deficit narrowed for February to $15 bn, and oil and gold prices continued to remain soft, fresh trouble in Cyprus and the pulling out of DMK from the UPA coalition put doubt in investors’ minds on the continuation of reforms and fiscal consolidation programme. Equity markets were also negative for the week putting a question mark on the robustness of FII flows which have been the mainstay in financing the trade deficit in the previous year. Further, fresh trouble in European nations due to likely bankruptcy of Cyprus banks, derailing a fledgling global recovery brought fears of weakness in software exports, another major source of foreign exchange.
With the correction in bond yields in the last few weeks, the 10-year benchmark yield at close to 8% seems fairly valued. As such, some bargain-buying may be on hand next week. However, the sentiment remains extremely unnerving with bond prices turning consistently lower. Some more volatility is still expected before a firmer trend returns. Even though analysts expect further rate cuts in coming monetary policies, the sentiment needs a boost from some positive developments. In the past few weeks, food item prices have softened somewhat. For example, egg prices are down 10% and sugar prices are down 20% in last three months. However, it is yet to reflect in CPI inflation. Further, exports have to show sustained recovery and the monsoon trend will have to emerge positive for markets to get the confidence back. Given that, more volatility and choppiness is expected in coming weeks.
