The yield on the 10-year benchmark government bonds fell to a 31-month low on optimism the central bank will cut interest rate by 50 basis points (bps) in its third quarter policy review on January 29, after wholesale inflation figures eased in December.
Earlier, the market was expecting a 25 bps cut in January policy followed by another 25 bps cut in March. On Monday, the yield on the 10-year benchmark bond ended at 7.8 per cent, compared with Friday’s close of 7.87 per cent.
The yield had dropped to these levels last on June 29, 2010 at 7.79 per cent. In less than a month’s time, the yields fell 34 bps.
Banks continued to borrow heavily from the repo window of the Reserve Bank of India (RBI), and according to market participants, some banks have taken advantage of arbitrage opportunities by lending those funds in the call market. Overnight rates closed at 8.09 per cent against eight per cent on Friday.
The wholesale price Index (WPI) inflation for December fell to 7.18 per cent from 7.24 per cent in November. “We are now hoping for a 50 bps repo rate cut on January 29,” said a gilts dealer with a state-run bank. The repo rate, the rate at which RBI lends money to banks, currently stands at eight per cent.
Banks borrowed Rs 96,820 crore from the liquidity adjustment facility (LAF) window on Monday, compared with Rs 91,510 crore on Friday. For the fortnight ended January 4, the Central government’s balances with RBI came down to Rs 19,726 crore from Rs 82,560 crore for the fortnight ended December 28, shows weekly statistical supplement of RBI.
In the second quarter review of the monetary policy, RBI’s WPI projection for March was raised to 7.5 per cent from seven per cent indicated in July. And RBI had projected December inflation of around eight per cent in its October policy review. However, rising for the third consecutive month, the consumer price index (CPI) inflation breached the double-digit mark at 10.56 per cent in December, driven by higher prices of vegetables, edible oil, pulses and cereal. It stood at 9.9 per cent in November.
But the central bank has not given much importance to CPI. “CPI has some promise as a replacement or a successor to WPI. But it’s still new and just a year old. We need to understand its properties and dynamics. But we look at it as a potential successor and at this point of time, it is in the evaluation process,” said former deputy governor of RBI, Subir Gokarn, at an event last month.
The street expects the yield on the 10-year benchmark bond to fall further to near 7.7 per cent in the days to come before January 29. However, the market expects corrections by the end of this month. “The yield may fall further, but ultimately, the movement will depend upon the policy decision.
If there is a rate cut with a guidance for more rate cuts, then the yields may keep falling. But if there is a rate cut with guidance for no more rate cuts for some time, the yields will rise,” said a gilts dealer with a private sector bank.
Few treasury heads agreed that despite government spending the borrowings continued to be high as banks are opting for arbitrage opportunities, something which RBI considers misuse of the LAF window.
