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Informist, Friday, Feb. 7, 2025

 

By Aaryan Khanna

 

MUMBAI – The Monetary Policy Committee's 25-basis-point repo rate cut was the minimum that bond traders expected on Friday, and the Reserve Bank of India's rate-setting panel delivered. Beyond that, new RBI Governor Sanjay Malhotra's cautious tone on further easing punctured the enthusiasm traders had carried into the policy meeting.

 

The repo rate was cut for the first time after the onset of the COVID-19 pandemic, falling to 6.25% from the 6.50% rate maintained over the past two years. For gilt dealers, the announcement in isolation was underwhelming, as they had expected the RBI's communication to set the stage for further policy easing.

 

Instead, Malhotra too refused to give any significant forward direction on policy rates, much like his predecessor Shaktikanta Das. When probed, he said the decision to shift to a less restrictive policy applied only for the February policy meeting. The MPC cited tail risks to inflation and the uncertainties on the global front from both market volatility and trade policy as a reason for unanimously retaining the policy stance at 'neutral'.

 

A section of the market had hoped this would change to "accommodative" to signal further monetary easing in light of growth seen slowing to a four-year low of 6.4% in 2024-25 (Apr-Mar). Even if that didn't happen, the base case traders had priced in were additional measures to improve liquidity conditions. Neither tone, nor action, suggested an immediate wave of liquidity was coming.

 

"The takeaway is that the RBI is taking it one step at a time on liquidity measures, but that gives the market no visibility on what is coming," Rajeev Radhakrishnan, head – fixed income at SBI Funds Management, said. "There is clearly a need to add liquidity, otherwise a rate cut will have no effect on the market or the economy."

 

With the extras not on the table, gilt yields across tenures rose despite the rate cut, having priced in more than the RBI was willing to give them Friday. The 10-year gilt yield rose nearly 5 bps to 6.70%, and is expected to tread water in the 6.60-6.80?nd for the rest of the financial year. This would bring it to the cusp on the next policy review.

 

STEEPER CURVE, EVENTUALLY

Perhaps the open market operation purchase calendar that some had hoped for was wishful thinking, but pangs of disappointment stemmed from the lack of follow up on the RBI's Jan. 27 trio of easing measures – through gilt buys, a long-term variable rate repo auction and a dollar/rupee buy/sell. So much was the disappointment that yields on even rate-sensitive short-term bonds maturing below three years, which should have ideally reset lower in tandem with the repo rate, also rose Friday.

 

Governor Malhotra promised the RBI would ensure an orderly evolution of liquidity, but none in the market read this as an indication they would have the liberty of a liquidity surplus coming soon. A new raft of liquidity measures is considered essential at a time when the RBI's dollar sales continue to pinch rupee liquidity. The currency in circulation drain with advance tax payments in March will only widen the liquidity deficit prevailing since mid-December. With all the potential pain incoming, some traders were wary of holding their extensive positions in bonds maturing under 10 years.

 

But the majority of the market said the case for a yield curve steepener remained intact, which protected some of the shortest-tenure securities from the brunt of the selling. Even though the spread of the 10-year gilt over the 5-year paper was unchanged after the rate cut, at 7 bps, the first sign of further liquidity infusion would draw banks immediately back to short-term bonds.

 

"While market participants are disappointed with no new explicit announcement on liquidity measures, we reckon such announcements do not need to be announced post-MPC per se and can be undertaken as and when needed," said Madhavi Arora, chief economist at Emkay Global Financial Services. "...more measures are on the anvil if RBI finds this level of deficit uncomfortable for policy transmission, especially as the depth of the cut cycle is still arguable." Arora expects the RBI to prefer more open market operations and dollar/rupee buy sell swaps, after nearly INR 600 billion of primary and secondary market gilt buys in January.

 

The yawning term premium of the five-year gilt, at 38 bps over the lower repo rate Friday against less than 10 bps Thursday, would make the case for buyers to flock to it as funding costs move towards 6.25%, dealers said. Meanwhile, a fall in yields of bonds maturing over 30 years is unlikely as they would compete for demand with long-term state bonds, supply of which peaks at the end of the financial year in March.

 

WATCH THE NUMBERS

While the first repo rate cut had been in the oven for a long time, timing the next cut was considered another game of watching the data. In a pre-policy note, Nomura wrote that the GDP data on Feb. 28 and CPI inflation on Feb. 12 were likely bigger drivers for the market to adjust to its house view of 75 bps of further rate cuts.

 

Traders had come into the policy pricing in nearly 75 bps of rate cuts over the next 12 months, but do not have much clarity beyond the base case of 50 bps after the policy. To be sure, the initial takeaway was that the RBI's rate-setting panel would cut the repo rate by another 25 bps to 6.00% sooner rather than later. The unanimity in the rate cut on Friday suggested the majority of members would favour another rate cut in order, essentially front-loading policy easing to combat sluggish growth.

 

"This decision, in my view, was a logical extension to the liquidity measures taken in January, along with clear assurances given by the Reserve Bank of India to support liquidity whenever necessitated, going forward," V. Lakshmanan, head of treasury at Federal Bank, said. "Friday's outcome sets the stage for rate cut expectations in April, unless inflation and global macro play havoc."

 

However, the RBI's future projection did not suggest that monetary policy would need to be very accommodative to prop up growth. The MPC expected economic activity to recover from the seven-quarter low growth of 5.4% in Jul-Sept. The RBI's 6.70% projection for FY26 matches with the government and betters FY25's estimated 6.4%, which economists say will be difficult to achieve. Should the MPC be looking at that realistically, it didn't have much room to cut rates, limiting the joy for bonds.

 

"Based on the RBI's projections, this is not a deep rate-cutting cycle, that's for sure," Radhakrishnan said. "You don't need too many rate cuts when you are projecting growth at 6.70% (for FY26)."

 

With no significant rate cuts ahead, supply pressures from state bonds will likely keep spreads between the 30-year and above gilts over the 10-year benchmark high, as seen since mid-January. Short-term yields will only follow the cut in the repo rate when the RBI walks its talk on liquidity, dealers said. With this, bond traders feel the MPC's historic rate cut lacks bite until there is enough liquidity to transmit it to the market.  End

 

Edited by Vandana Hingorani

 

 

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