Indian bonds trade flat ahead of RBI policy meet

The Indian 10-year bond yield is unchanged on Monday ahead of RBI’s monetary policy meeting on Tuesday where the Reserve Bank of India is widely expected to cut the repo rate by 25bps. The 10-year bonds yield, which is inversely propositional to bond price remained unchanged at 7.46 pct and 3-year bonds yield stood at 7.37 pct at 7:00 GMT.

The fall in Indian bond yields is likely to accelerate as market is expecting a 25bps cut in the next policy meeting on next Tuesday. Moreover, pressure on the central bank is mounting for a rate cut, especially after the government stuck to the budget deficit target of 3.5% of GDP for FY17.

This is consistent with the assessment that recent Indian economic data have improved a bit -CPI inflation moderated to 5.2% y/y in February from 5.7% y/y in January. However, given that service sector inflation remains high, it will be important to assess the tone of the monetary policy statement, as we believe that there are upside risks to the RBI's FY17 inflation target of 5%.

“Bankers expect yields to fall by 15-20 basis points over the next one month. “There is still steam left in the bond rally. A fall to 7.25% yield for the 10-year bond is quite possible,” said Sidharth Rath, president-treasury, corporate and transaction banking at Axis Bank.

For the bond rally to sustain, a rate cut by the RBI on 5 April would not be enough as such a move has already been priced in. In fact, a section of the market expects a deeper 50 basis point cut in the repo rate. The central bank would have to indicate that systemic liquidity deficit would be addressed and that it would use all instruments to infuse liquidity.

We foresee that the RBI will primarily focus on the domestic liquidity situation. In the recent week, systemic liquidity has tightened considerably due to the government holding back on spending and maintaining large cash balances with the RBI.